TipRanks Smart Dividend Newsletter – Edition #39
Hello and welcome to the 39th edition of TipRanks’ Smart Dividend – a weekly Newsletter providing you with investment ideas for safe-bet quality stocks that are outstanding dividend payers, compared to their peers.
Investment Thesis: Stability in Tech
The IT sector is well-known for rapid innovation and growth, though this often comes at the expense of stability. However, there does exist a subset of tech companies that lead in both innovation and advancement as well as in providing financial returns to shareholders, particularly through dividends.
Dividend-paying IT firms offer investors a dual promise: the potential for appreciable capital growth driven by sectoral innovations and a steady stream of income that can provide a buffer in volatile market conditions. Investing in such companies within the IT sector presents a compelling opportunity for those looking to balance the growth potential inherent in technology with the stability offered by dividends. Let us present one such company, which we view as a compelling income investment idea.
This Week’s Quality Income Stock Idea
The International Business Machines Corporation (IBM), aka Big Blue, is an information technology (IT) and IT consulting company. IBM provides integrated solutions and services worldwide. The company offers application, technology consulting and support, process design and operations, cloud, digital workplace, and network services, as well as business resiliency, strategy, design, and financing solutions.
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Company Overview
Founded in 1911, IBM in many ways originated the IT industry, which didn’t exist before the company began delivering its groundbreaking innovations. These included the ATM, RAM, magnetic storage technology, Fortran and SQL, the UPC barcode, the PC, networking protocols, the UPC barcode, and more. IBM helped to launch the first Apollo mission to the Moon, while its “thinking machine” Deep Blue was the first step towards today’s Artificial Intelligence (AI) technology. The company holds a U.S. record for the most patents generated by a single business.
Today, IBM ranks #65 on the Fortune 500 list of the largest U.S. firms. It operates in 175 countries and employs approximately 350,000 people. IBM services over 5,200 business clients, which include 95% of the Fortune 500 firms.
The company’s stock has been traded on the New York Stock Exchange (NYSE) since 1915. It is a member of the S&P 500, the Dow Jones Industrial Average, Russell 1000, and numerous other indexes.
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Business Prospects
Despite its lingering perception as a research powerhouse with weak business capabilities, IBM has been rapidly modernizing its business. After spinning off its legacy business of managed infrastructure services, IBM has been focusing on higher-margin, faster-growing opportunities. Software (particularly hybrid cloud platforms) and consulting now provide 75% of total revenues, with over half of them recurring, making revenues highly visible and predictable. IBM has acquired several firms focusing on hybrid cloud, IT automation, and data analytics, positioning itself for accelerated revenue growth.
Another key area of growth is AI. IBM has developed an extensive suite of AI tools, with its platform providing access to AI-as-a-Service for businesses. These tools enable users to build, run, and manage AI models, optimize decisions at scale across any cloud, and direct, manage, and monitor AI projects. IBM’s extensive and hyper-integrated ecosystem of platforms, software, and consultancy provides unique support that allows its business clients to transform their corporate operations.
Another pillar of support is IBM’s extensive partnerships with all large public cloud providers and other big SaaS players, such as AWS, Adobe, Cisco, Microsoft, Oracle, Salesforce, Samsung, SAP, and others. The company has also signed an agreement with Meta Platforms to integrate Llama 2, a generative AI model that specializes in language tasks, into its AI platform. These partnerships reduce competition while producing rapidly growing consulting revenues for IBM.
In addition to being a B2B IT powerhouse, IBM occupies a central stage in the money movement around the globe. The company’s mainframe computers, IBM Z, handle 90% of all credit card transactions globally, as almost all leading banks around the world use these machines. Incredibly, IBM’s machines are responsible for providing half of all wireless connections in the world. In every way, the company’s computer systems serve as one of the pillars supporting the global economy.
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Dividend Analysis
IBM began paying dividends over a century ago in 1916. The firm is a Dividend Aristocrat, featuring 28 years of consistent dividend increases. Its current dividend yield stands at 3.6%, well above the IT sector’s average of 1.0% and much higher than its competitors’ payouts.
In the past decade, the dividend has grown at a CAGR of 6%, slowing down to ~2% in the past five years. Given its already high payout, IBM is expected to grow its dividend at a similar rate in the years to come. The safety of the dividend is supported by the company’s moderate cash payout ratio of 49%, leaving IBM with ample free cash after accounting for dividends. Its adjusted EPS-based payout ratio is higher, but not exceedingly so at 70%.
With a history of dividend payments spanning over a hundred years and a track record of constant payout increases for almost three decades, IBM stands out as one of the most reliable dividend payers in the market, and certainly the most reliable one in the Information Technology sector.
IBM is the only classic dividend stock among the large technology names, with the payouts comprising over 80% of the total return in the past decade. While dividend payouts have continued to grow steadily in recent years, the company’s business rejuvenation has added more capital gains to the mix, and in the past five years, dividends comprised ~40% of the total shareholder return. As the business turnaround is ongoing, the expected upside from IBM’s AI-powered cloud business is projected to further support earnings growth and strong returns for the stock.
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Total Return Outlook
On January 24, the company reported its fourth-quarter and full-year results for 2023, beating analysts’ estimates on revenue and earnings. In fact, IBM surpassed analysts’ EPS projections in 14 out of the last 16 quarters, underscoring the turnaround in its business towards growth. In the past three years, EPS grew at a CAGR of 23%, a complete U-turn from previous weak numbers.
In 2023, IBM further expanded its industry-beating margins and increased its already-large cash reserves. The FCF increased from $9.3 billion in 2022 to $11.2 billion in 2023, with the company expecting it to rise even further to roughly $12 billion this year. The robust full-year results include growth across various segments, showing that IBM’s strategic focus on enhancing its software and consulting businesses is bearing fruit, further supporting the company’s ability to raise dividends for the foreseeable future.
Due to the better-than-expected results last quarter and over the course of the past year, several analysts lifted their revenue and EPS targets for the company. As a result, its stock price targets were also increased at Bank of America, Evercore ISI, Stifel Nicolaus, Morgan Stanley, and other prominent investment firms. IBM carries a TipRanks Smart Score rating of 9/10 (“Outperform”):
As a result of the company’s newfound growth positioning, its stock began trending higher in 2023 after trading sideways for several years. In the past three years, IBM shares gained 65%, while in the 12 months, they surged by 43%.
Despite the rally in the stock, it continues to trade at very attractive valuations. IBM is undervalued compared to the IT sector, industry, and peer average. In addition, it trades about 30% below its fair value, based on future estimated cash flows. These factors position IBM within the value stock universe.
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Investing Takeaway
To conclude, IBM is a very large, stable, low-risk business with a sticky customer base and a strong competitive position in its sector. The company has been striving to better position itself for growth, and its efforts are clearly paying off. With strong fundamentals and an improving outlook, IBM’s highly reliable, substantial dividend is expected to grow for years to come. The stock’s current valuations suggest that IBM combines both value and income proposition, and therefore is well-suited to be a part of long-term income portfolios.
Disclaimer
The information contained in this article represents the views and opinions of the writer only, and not the views or opinions of TipRanks or its affiliates and should be considered for informational purposes only. TipRanks makes no warranties about the completeness, accuracy, or reliability of such information. Nothing in this article should be taken as a recommendation or solicitation to purchase or sell securities. Nothing in the article constitutes legal, professional, investment, and/or financial advice and/or takes into account the specific needs and/or requirements of an individual, nor does any information in the article constitute a comprehensive or complete statement of the matters or subject discussed therein. TipRanks and its affiliates disclaim all liability or responsibility with respect to the content of the article, and any action taken upon the information in the article is at your own and sole risk. The link to this article does not constitute an endorsement or recommendation by TipRanks or its affiliates. Past performance is not indicative of future results, prices, or performance.
