Microsoft, Intel Or IBM: Which Is Best For Long-Term Dividend Investors?

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Includes: IBM, INTC, MSFT
by: Brian Nichols

Summary

MSFT's 16.1% dividend hike gets its forward yield to 3.3%, putting it, INTC and IBM on the same level.

Of MSFT, INTC and IBM, which has the free cash flow to afford its dividend payments and buybacks?

The answer may surprise you.

After Microsoft's (NASDAQ:MSFT) 16.1% dividend increase, its yield is now up to par with the technology industry's dividend elite, Intel (NASDAQ:INTC) and IBM (NYSE:IBM). With each stock paying a forward yield well in excess of 3%, and most investors liking to hold at least one high yield, large technology company in their portfolio, it might be beneficial to determine which of these three dividend stocks is best to own long term.

One of the first things dividend investors look at when deciding between two or more long-term dividend investments is the payout ratio. This is the percentage of net income that a company pays in dividends, and tells investors whether a company's dividend is affordable and whether a company can continue to increase its dividend. If you look strictly at the payout ratio, you would likely conclude that Microsoft made a big mistake in increasing its quarterly dividend. Microsoft's payout ratio is 82% vs. Intel and IBM each with a payout ratio well under 40% each. However, payout ratios can be very misleading.

Specifically, payout ratios deal with net income, and net income takes into account one-time events and does not properly weigh capital expenditures. For example, Microsoft reported a $7.5 billion impairment charge related to its Nokia handset acquisition. That charge was reported on its income statement against net income, but was a one-time event, thereby not relevant to whether Microsoft can afford its dividend long term.

That's why it's much better to look at a company's dividend payments vs. free cash flow, a metric of bottom line performance that is much more consistent year to year and accounts for capital expenditures. In other words, free cash flow is a better reflection of profits, thereby telling investors whether a company can afford its dividend.

Microsoft

IBM

Intel

FCF 12-month

$23.1 billion

$13.2 billion

$10.8 billion

Dividend Payout Forward 12-Month

$11.5 billion

$5.09 billion

$4.57 billion

Payout/FCF ratio

49.7%

38.5%

42.3%

As you can see, the metrics for dividend payouts are much more aligned when taking into account FCF. And clearly, it does appear that IBM has the most secure dividend with the highest chances to increase its dividend long term. Not to mention, IBM also has the highest dividend yield of the three stocks, 3.6% vs. 3.3% on a forward 12-month basis.

With that said, there is one other element to consider, and that's buybacks. While it's not uncommon for large, well-established tech companies to return 100% of their FCF to shareholders via buybacks and dividends, what's important is that companies don't exceed that line. So long as they stay under, there's still dividend or buyback upside and that's good news if you are a long-term dividend investor.

MSFT Stock Buybacks (<a href=

MSFT Stock Buybacks (TTM) data by YCharts

With Microsoft spending 59.7% of its FCF on buybacks, and 49.7% on dividends, it returns well over 100% of its FCF to shareholders, approximately 109.4% on a forward-looking basis. Intel actually spends more than Microsoft on dividends and buybacks, nearly 125% of FCF. While some might be encouraged by this spending, I view it as unsustainable and prefer to see companies' FCF positive after dividends and buybacks, so that a company's cash and equivalents can rise or acquisitions and other investments can be pursued.

For the longest time, IBM spent far more than it could afford on dividends and buybacks combined. However, it has become far more responsible, now spending just 65.9% of FCF on dividends and buybacks. That makes IBM a terrific long-term dividend investment, allowing the company significant cash to spend on acquisitions, increase its dividend, or to make other investments to better its business.

That said, IBM has a complex set of issues surrounding its business, having seen its trailing 12-month revenue and FCF decline 18.8% and 15.8%, respectively, since 2012. However, IBM's declines are starting to stabilize, especially FCF which is expected to be flat year over year. Thus, given IBM's responsible spending and a 25% stock loss over the last year, it might just be time to buy IBM for the long haul, especially over Intel and Microsoft.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.