International Business Machines (NYSE:IBM) last announced a dividend increase in April of this year, boosting its quarterly payout to $1.40 per share, an 8% increase. This marked the 21st consecutive year in which IBM increased its dividend and the 100th consecutive year in which IBM has paid a dividend to investors. IBM isn't quite a Dividend Aristocrat, but it's getting close.
IBM stock yields about 3.5% based on this increased dividend payment, already higher than many of its tech peers. With earnings in decline, driven by the company's ongoing transformation, are investors likely to see another dividend raise in 2017?
Can IBM afford it?
Despite more than two decades of dividend hikes, IBM still has room to grow its dividend. The company expects to produce at least $13.50 in operating EPS this year, a number that backs out a couple of non-cash items and better represents IBM's true profitability. Assuming IBM hits this guidance, the company will pay out about 41.5% of earnings in the form of dividends. Things are a bit tighter when free cash flow is considered. IBM expects to produce roughly $12 billion of free cash flow this year, putting the payout ratio based on free cash flow at a higher 45%.
With IBM actively buying back shares, with the aim of reducing its share count by a few percentage points annually, only a steep decline in earnings could derail a dividend increase in 2017. If IBM comes up short of its earnings guidance for this year and expects another substantial decline next year, the company may end up holding off on raising the dividend. Otherwise, a small dividend increase shouldn't be a problem, and a larger increase is possible if earnings hold up better than expected.
Returning to growth
Going beyond 2017, keeping the streak of dividend increases going will require IBM's transformation to bear fruit. The company has been investing heavily in growth businesses like cloud computing and analytics, shifting resources away from legacy businesses as it transforms itself into a cognitive and cloud computing company. Those growth businesses are growing quickly, but declines in other segments have led to years of revenue declines.
During the second quarter, IBM's strategic imperatives, which include cloud, analytics, mobile, social, and security, grew by 12% year over year. That's a slowdown compared to recent quarters, but these businesses have generated $30.7 billion of revenue over the past year, about 38% of IBM's total revenue. Acquisitions are helping to drive this growth, with IBM snapping up companies in an effort to build out its portfolio of products and services.
Meanwhile, total revenue slumped 3% year over year during the second quarter, knocked down by declines in legacy businesses. It's unclear exactly when IBM's strategic imperatives will become large enough to offset weakness elsewhere, but it hasn't happened yet.
IBM's earnings are going to need to bottom out and begin growing again soon if the streak of dividend increases is to be extended much further. The company's strategy is sound: go after areas where it can gain a competitive advantage, with a focus on enterprise customers. IBM isn't trying to make its cloud business the largest, for example. Attempting to compete on price in the infrastructure-as-a-service market is unlikely to be a good use of capital for IBM.
I would be surprised if IBM didn't raise its dividend in 2017, but the company's turnaround needs to start producing tangible results for its dividend streak to continue beyond next year. IBM could join the ranks of Dividend Aristocrats in a few short years, but that would require a return to earnings growth sooner rather than later.
Timothy Green owns shares of IBM. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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.