Big Blue's Big Buy

Each week, Foolish friend Rick Munarriz profiles a handful of companies that have hiked their dividends. (Find the latest here.) There's a good reason for this: Firms that boost dividends tend to steadily increase cash flow in the long run. Higher cash flow often leads to higher stock prices. That's why IBM's (NYSE: IBM  ) plan to raise its dividend by 50% is so intriguing.

Big Blue announced the move yesterday, along with a $4 billion expansion of its stock buyback program. (That's in addition to the $2.5 billion IBM had already earmarked to repurchase shares.) The hike is the largest in the history of the computer services firm, which has paid dividends to shareholders since 1916, and has hiked its quarterly payout for 11 years running.

So that means IBM's business is improving, right? Honestly, I'm not so sure. A check of Capital IQ shows that IBM's cash from operations has been roughly flat since 2001. And while per-share earnings are expected to rise by about 20% during 2006, much of that increase could be due to the share buybacks. In other words, there's no guarantee that cash is flowing any faster than it always has.

It seems more likely to me that IBM has finally found a business model that offers relatively predictable growth. After all, with a payout ratio of only 16%, Big Blue has had plenty of opportunities to boost its dividend more than it has over the years. And the buybacks make sense: IBM is trading for just 13 times forward earnings. The stock hasn't been that cheap since 1996. Look what's happened since.

The Foolish bottom line is that there could be any number of reasons why IBM has chosen to return moola to shareholders now. I'd like to believe it's because the business is improving, but it just doesn't seem that way. Regardless, this move has all the markings of smart capital allocation that's likely to be rewarding for patient investors. A Fool can hardly ask for more than that, right?

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Fool contributorTim Beyersworked at Sun when it was the dot in dot-com. Tim didn't own stock in any of the companies listed in this story at the time of publication. You can find out which stocks he owns by checking Tim's Foolprofile. The Motley Fool has an ironcladdisclosure policy.


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