The information technology services sector is a diverse group of stocks providing various IT services to businesses and government agencies. The services provided by these companies can range from hosting client software on in-house datacenters, to business consulting, cloud computing services, and Hardware deployment. Growth in the industry has been slow throughout the recession and the recovery period, and the industry is expected to grow at compound annual growth rate (CAGR) of just 4.7% between 2010 and 2015. Even though growth for the industry is expected to be slow and steady, some pockets within the sector are expected to grow much quicker. For example, hosted application management services are expected to have a 9.5% CAGR over the same period, and cloud computing services are expected to grow by a 27% CAGR during that time. Many of the companies in this industry are dividend payers and have histories of increasing dividends. Dividend growth investors would be wise to scan the IT services sector to determine whether any of these companies could help bolster the dividends and returns of their portfolio.
International Business Machines Corp (IBM)
IBM, Big Blue, is an American multi-national technology and consulting firm. While IBM falls within the IT Services sector, the company's offerings are diverse, ranging from software to cloud computing, and business consulting. Despite volatility in the IT industry over the past decades, IBM has been able to deliver a steady track record of increasing EPS. The company has shifted its business away from personal computers and other commodities, and towards high value areas such as services, software, and service integrations. This shift has moved the company away from offering products as solutions toward integrated solutions that generate increased business value from IT investments for clients. The company has a consulting presence in major industries like financial services, government, communications, and industrials, but the companies that IBM works with span all market sectors.
IBM is a giant in the world of IT Services, with a market cap of $237B versus the sector average of $10B. As of this writing, IBM trades for $206.37 with a TTM P/E ratio of 15.1, slightly above the five year average P/E of 13.1. In 2011, IBM produced full year revenue of just under $107B. Over the past five years, IBM has grown EPS by a 16.6% CAGR, and expectations are for EPS to continue to grow by nearly 10% over the next five years.
This Warren Buffett approved dividend growth stock currently pays a $3.40 annual dividend, which at today's prices equates to a 1.63% yield. Based upon estimated EPS from 2012 of $15.14, IBM is expected to pay out just 22% of earnings as dividends. IBM has increased their dividend annually for the past 17 years, and over the past 5 has managed a CAGR of 16.27%.
IBM appears poised to be a sound investment for dividend growth investors for years to come. The company expects double digit earnings growth, which should continue to reward investors with capital gains in the years to come. In addition to solid capital gains, IBM has significant room to grow its dividend thanks to its EPS growth, and low payout ratio. While IBM may not be able to grow dividends at 16% for years to come double digit growth is not out of the question. I believe is a great company, and possibly a better stock, but investors should hope for the stock to pull back to bring the P/E more in line with historical averages before jumping on board (~$180).
Accenture PLC (ACN)
Accenture is a leading management consulting, technology services, and outsourcing company based in Ireland. ACN operates primarily in the three service areas mentioned, but supports industries from automotive, consumer goods, life sciences, retail, and everything in between. ACN focuses primarily on helping clients improve operational performance and identify areas for implementing efficiencies.
Accenture is much smaller than IBM, but still has a market cap of $48B. As of this writing, shares of ACN are trading at $69.54, giving them a TTM P/E of 18.3, above the five year average P/E of 15.0. Over the previous 12 months, ACN has increased EPS by 13% versus the 12 months prior, and over the next five years EPS are expected to grow at a CAGR of 11.3%.
Accenture has an 8 year history of increasing annual dividends, but pays those dividends on a semi-annual basis rather than the typical quarterly structure. With a dividend payout of $1.485 for 2012, the stock has a payout ratio of 38.6% based upon 2012 EPS of 3.84. ACN has grown its dividend at a CAGR of 26.3% over the past five years, with this year's increase coming in at 20%.
Accenture is another stock in the IT service industry for investors to consider. The company provides diverse service offerings, and is a big name within the industry. For investors, the company is debt free, expecting double digit earnings growth, and has a dividend payout ratio below 40%. Shares of ACN may be able to increase further as EPS increases, and the dividend should continue to rise as well. ACN is another solid company, and may provide investors with significant returns in time, but for now I would stay on the sidelines with this one, and wait to see if the stock can come down to a more reasonable valuation before investing. I would buy in to Accenture below $60, but for now, the stock trades at a significant premium to that valuation.
Computer Science Corp (CSC)
Computer Science Corp is a much smaller IT services and consulting firm than either IBM or Accenture, but still operates worldwide. The company, which is headquartered in Falls Church Virginia, provides IT and business process services, cloud computing services, systems integration support, and other professional services.
With a market cap of just a bit under $5B, CSC is just a fraction of the size of IBM and Accenture. Shares of CSC, currently trading for $31.29, sport a TTM P/E ratio of 13.48, significantly below the industry average of 26.7 or the five year industry average of 19.5. EPS for CSC have increased significantly over the past five years with a CAGR of 65%, and over the next five years earnings are expected to grow by 8% annually.
CSC does not have the established dividend history of either ACN or IBM, having just begun to pay dividends in 2010. In those two years, the dividend payment has increased from a $0.60 annual dividend to a $0.80 dividend payment giving shares a 2.56% yield. Based upon TTM earnings, CSC would have a payout ratio of 34%.
As a much smaller company, CSC faces a number of challenges, in both grabbing market share and obtaining the economies of scale of the much larger ACN and IBM. A CSC sports razor thin margin compared to their larger competitors, and does not have the established name and reputation of some of the other industry players. With that being said, CSC could be an intriguing stock for investors to consider. While not a typical dividend growth stock, given the lack of dividend history, CSC trades at more investor friendly valuation than its larger competitors. In addition, if management were to institute another dividend increase prior to the Q4 payment, the stock would now have three years of consecutive increases, and be on their way to building that dividend history that gets investors attention.
While CSC could be an intriguing opportunity for investors, I would sit this one out until we hear from management regarding the future of the dividend. If another dividend increase is forthcoming, CSC could be a stock that surprises investors with capital gains and annual dividend increases in the years ahead.
The IT services industry faces many headwinds, particularly decreased government spending. The effects of the pending fiscal cliff and potential for government sequestration cannot be understated. In the event of sequestration, all companies operating within this industry will be affected to varying degrees, but I don't believe that sequestration is truly a likely scenario (but given the gridlock that has been congress, it is difficult to predict what will happen). What can be predicted is that consolidation of government and business services are likely to occur in an effort to save money, and these companies will likely be involved in leading those changes.
IBM and Accenture appear to be well positioned to be major players in the systems integration, strategic management, and other organizational changes that take place in the years ahead. Both are excellent stocks that DGI investors should keep an eye on, but determine what an appropriate entry point would be. CSC is an interesting stock, but a much smaller player in the industry, and would be a more speculative investment at this time. I would continue to monitor CSC to see how the company and the stock evolve over the coming quarters to determine whether it could be a worthwhile investment. Dividend growth investors can look to the IT service industry for some terrific dividend growth stocks that could expand their portfolios with growing capital and increasing dividend streams
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.