Seeking Alpha
Research analyst, contrarian, special situations, deep value
Profile| Send Message|
( followers)  

IBM (NYSE:IBM) has prodigiously grown its dividend over the past decade, and by 2011 it was paying out almost 5x what it did in 2002. The compounded annual growth rate of the dividend is just over 19%, and during the past five years, IBM has maintained ~18% growth in its dividend. The dividend growth alone is enough to make me start to understand why Warren Buffett invested in IBM.

In April, the company announced it would be raising its quarterly dividend 13%, to $0.85 per share. This was 17th year in a row that IBM has raised its dividend.

YearDividendDividend Growth
2002$0.59--
2003$0.637%
2004$0.7011%
2005$0.7811%
2006$1.1041%
2007$1.5036%
2008$1.9027%
2009$2.1513%
2010$2.5016%
2011$2.9016%

IBM has also been extremely effective at growing its free cash flow per share, which has increased every year over the past decade. And the company does not show any signs of slowing down. Both the 5- and 10-year compounded annual growth rate for FCF/share is ~12%.

Additionally, the board of directors have authorized $7B in additional funds for the company's stock repurchase program. IBM has reduced its share count by a third since the beginning of 2000.

IBM's payout ratio further illustrates the company's ability to generate cash flow. The payout ratio is an incredibly low for 16%. This is low, even when compared to companies with strong cash flow and low payout ratio, such as Microsoft. If IBM expanded its payout ratio to just 25%, the 2011 dividend could have been >50% higher.

YearFCF/SharePayout Ratio (Div/FCF per share)
2002$6.539%
2003$7.279%
2004$8.248%
2005$8.719%
2006$9.5612%
2007$11.2813%
2008$13.2814%
2009$14.1115%
2010$16.0116%
2011$17.7716%

Dividend Discount Model

Using the dividend discount model, I determined the value of the company based on its future dividend payments. In performing this valuation, I made several assumptions. First, I used 9% as my discount rate, based on the long-term average return of the stock market. Second, I used IBM's 13% dividend increase to set the dividend for 2012 ($3.30/share).

I used a constant growth rate of 18% for years 2013-16, a 15% growth rate for 2017-20, and a 12% rate for 2021-22. Finally, I assumed a 5% perpetuity rate after 2021.

Based on these assumptions, I calculated that IBM's intrinsic value is $204.27 per share. At the current price, the stock is ~5% below its intrinsic value.

Given IBM's history of dividend and free cash flow growth, dividend growth investors may want to put this stock on their radar. I believe it is fairly valued, but does not provide a margin of safety, based on a dividend discount model approach. However, any significant decline is likely a buying opportunity for long-term investors.

Source: IBM: Strong Dividend Growth At A Fair Price

Additional disclosure: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the dividend growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.