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Forget HP, IBM Is a Better Dividend Stock

By Leo Sun – Dec 2, 2019 at 6:23AM

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Big Blue boasts a bigger dividend, a better diversified business, and a clearer path towards a sustainable recovery than HP.

HP (HPQ) and IBM (IBM 1.56%) are both considered slow-growth stalwarts of the tech industry, and are generally owned for stability and income instead of growth. However, investors who are mainly interested in dividends should consider Big Blue a better income play than HP, for three reasons.

A higher yield with a more generous payout ratio

HP pays a forward yield of 3.5%. That equals $0.70 per share in annual dividends, but only 31% of its non-GAAP EPS forecast for 2020. It's raised that payout every year since its split with Hewlett Packard Enterprise (HPE -0.28%) in late 2015.

A canvas bag labeled "dividends".

Image source: Getty Images.

IBM pays a forward yield of 4.8%, which equals $6.48 per share in dividends per year. That equals 50% of its non-GAAP EPS forecast for the year. It's hiked that payout annually for 24 straight years, which puts it on track to become a "Dividend Aristocrat" -- a member of the S&P 500 that's raised its dividend for at least 25 straight years -- in 2020. Therefore, IBM's higher yield, higher payout ratio, and longer streak of dividend hikes all make it a more appealing income play than HP.

A better diversified business

HP generates its revenue from two core businesses: personal systems (PCs and workstations) and printers (hardware and supplies). The personal systems unit, which generated 68% of its revenue last quarter, remains stable.

However, the ongoing decline of its printing unit -- which is struggling with weak sales of hardware and supplies -- is offsetting that growth. A major sore spot is its higher-margin supplies unit, which is losing ground to cheaper generic ink and toner suppliers.

IBM's business is split into five main units: cloud and cognitive software (29% of its revenue last quarter), global business services (23%), global technology services (37%), systems (8%), and global financing (2%). The cloud and cognitive unit, which includes is cloud services and Red Hat, is its core growth engine.

IBM's other businesses (especially systems, which is in a cyclical downturn) are weaker, and frequently offset the stronger growth of its newer businesses. Nonetheless, it continues to make progress in cloud platforms and services, which accounted for 27% of its revenue last quarter, and its growth could improve as cyclical orders of systems accelerate and it reaps the revenue-boosting benefits of its Red Hat acquisition.

IBM's z14 mainframe.

Image source: IBM.

At first glance, HP and IBM both seem weighed down by weaker businesses. But IBM has more irons in the fire, while HP's earnings growth remains shackled to its sickly printing supply business.

A stronger long-term outlook at a similar multiple

Over the past 12 months, HP's stock slipped 10% as IBM's stock rose 15%.

The bulls likely favored IBM because its cloud business was still growing, the Red Hat acquisition would boost its revenue and expand its ecosystem, and its systems sales would likely improve with the start of a new product cycle. That's why analysts expect IBM's revenue and earnings to improve 3% and 4%, respectively, next year.

Meanwhile, the bears pounced on HP because the weakness of its printing unit was overwhelming the stable growth of its PC business. The abrupt departure of its CEO and a hostile bid from Xerox (XRX) caused even more confusion. Analysts expect HP's revenue to decline 1% next year as its earnings rise less than 1%.

Both stocks look fundamentally cheap: IBM trades at just ten times forward earnings, and HP has a slightly lower forward P/E ratio of nine. But after taking into account IBM's higher yield, better diversified business, and clearer growth path, it's easy to see that Big Blue is a stronger dividend stock than HP.

Leo Sun owns shares of HP. The Motley Fool is short shares of IBM. The Motley Fool recommends the following options: long January 2020 $200 calls on IBM, short January 2020 $200 puts on IBM, and short January 2020 $155 calls on IBM. The Motley Fool has a disclosure policy.

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