What Does IBM Do With Its Free Cash?

Many companies talk about how they enhance shareholder value by returning cash through dividends or stock buybacks. But investors shouldn't just take the company's word for it. In this series, we'll investigate how companies have spent free cash flow over the past five years. By doing so, we hope to gain insight into whether the company's management might be good stewards of shareholder capital.

Today, we'll take a look at technology-services giant IBM (NYSE: IBM  ) .

How does it spend free cash?
First, let's have a look at how much free cash flow the company has generated in each of the past five years and how much has gone toward dividends and buybacks.

 

2010

2009

2008

2007

2006

Buybacks

$15,375

$7,429

$10,578

$18,828

$8,084

Dividends

$3,177

$2,860

$2,585

$2,147

$1,683

Total Paid

$18,552

$10,289

$13,163

$20,975

$9,767

FCFE

$15,915

$16,786

$13,671

$8,848

$11,337

Source: Capital IQ as of July 21, 2011. Figures in millions.
Free cash flow = net income depreciation-capital expenditures-change in noncash working capital.

IBM has a long track record of dividend payments. It's been paying quarterly dividends each year since 1916 and has raised its payout for 16 consecutive years.

Cumulatively over this period, however, IBM bought back more than $60 billion of its shares -- nearly five times as much as it paid in dividends. Despite the long dividend track record, it seems IBM loves its own shares more than it does paying out dividends.

Is the dividend covered?
Next, let's see how much of the company's free cash flow has gone to dividends.

Metric

2010

2009

2008

2007

2006

FCF Payout Ratio 20% 17% 19% 24% 15%

Source: Capital IQ, a division of Standard & Poor's.

It's clear that IBM can afford to spend a little more on dividends, but the current payout (1.6% dividend yield) is covered five times over by free cash flow. Even though the yield is slightly below the S&P 500 average of 1.8%, you can feel good knowing that IBM's dividend doesn't appear to be in danger.

Is it a good investor?
Companies are notoriously bad investors in their own stock. Consider that in 2007, when the market was hitting record highs, S&P 500 companies bought back a record $589 billion, versus $246 billion in cash dividends. In 2009, when the market was around its nadir, buybacks hit record lows.

Is IBM an exception?

Source: Capital IQ, a division of Standard & Poor's.

Not bad. In hindsight, it looks as though IBM's large buyback in 2007 was a good use of shareholder cash. Thereafter, buybacks seem to have followed the share price, but I'll give IBM credit for buying back stock in late 2008 and early 2009, when many companies were holding on to their cash tighter than Mr. Burns.  

Competitors
How does IBM's use of free cash flow stack up against some of its major competitors over the past four quarters?

Company

Free Cash Flow

Share Buybacks

Dividends

IBM $15,436 $15,275 $3,177
Accenture (NYSE: ACN  ) $2,416 $2,179 $464
Hewlett-Packard (NYSE: HPQ  ) $8,618 $11,507 $715
Microsoft (Nasdaq: MSFT  ) $20,521 $14,138 $4,960

Source: Capital IQ, a division of Standard & Poor's. All figures in millions as based on trailing-12-month data.

Foolish bottom line
IBM has been a consistent generator of free cash flow. Management seems to prefer buybacks to dividends, but to its credit, IBM has increased its dividend per share by 8% annualized over the past five years. I would prefer dividends and buybacks to get more equal funding over time, but it appears that, by and large, the company has prudently used free cash flow.

Todd Wenning is the advisor of Motley Fool (UK) Dividend Edge. You can follow him on Twitter. He owns no shares of any company mentioned. Motley Fool newsletter services have recommended buying shares of Accenture and Microsoft and creating a diagonal call position in Microsoft. The Fool owns shares of IBM and Microsoft.

We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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  • Report this Comment On July 22, 2011, at 2:10 AM, midwestson wrote:

    I purchased IBM in the mid 90's.for $40. It ran up to 180, split, ran up again to 180 and split again. Historically the company has split when the stock rises above 180, is it on tt verge of a split?

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