International Business Machines (IBM -0.29%) is a long-standing powerhouse in the enterprise technology world, with a storied history in hardware and software. Its stock is also popular with retirees, partly because IBM is such a recognizable brand, and also because of its demonstrated consistency as a dividend payer. It's a Dividend Aristocrat with a 26-year streak of annual payout hikes.
But technology is a game of innovation, and it's questionable how well IBM is evolving to stay relevant. Should investors be worried about the company's ability to maintain its dividend, which at current share prices yields a juicy 4.6%?
Cracks are showing in IBM's dividend
Dividends are a cash outlay, meaning that a business must fork over actual cash to pay one. They can't be "faked" with fancy accounting adjustments like bottom-line profits sometimes can be. That's why it's so impressive when a company can keep paying a dividend and increasing it year after year. Steady revenue growth is the most straightforward way for a company to become an outstanding dividend stock.
But IBM's top line hasn't grown over the past decade. For years, its primary focus was on selling IT infrastructure and massive computer systems to large companies. However, that business has steadily declined as more companies shifted to cloud computing solutions. IBM spun off its IT infrastructure segment as Kyndryl (KD -1.59%) in late 2021 to intensify its focus on the cloud and artificial intelligence.
As IBM's revenue has steadily declined, its growing dividend has driven its payout ratio higher. Once something of an afterthought, the dividend now consumes the majority of the company's income -- almost 59%. IBM has tried to slow the growth of this problem down, enacting minuscule payout increases over the past couple of years. Its most recent raise was just 0.6%.
When a business is struggling with revenue growth, that's concerning, but the picture looks even more worrisome when one focuses some attention on IBM's balance sheet. Over the past decade, the company has spent heavily on things such as share repurchases and acquisitions like open-source software company Red Hat, which it bought in 2019 for $34 billion.
The chart above shows how the company's debt has increased. Looking at the debt-to-EBITDA (earnings before interest, taxes, depreciation, and amortization) ratio shows you how much debt IBM has compared to its cash profits. IBM's debt-to-EBITDA has risen to 4.5, which leaves little financial wiggle room for the company. It still carries an investment-grade A- credit rating from Standard & Poor's, but it might not have a lot of room for error moving forward.
The dividend seems safe for now
Despite these concerning signs, IBM's dividend is likely safe for the time being. The company still has more than $7 billion in cash on the books, and the dividend payout ratio isn't so high that it's likely to force drastic actions.
However, given that things are trending in the wrong direction, the question must be asked: How does it get back on track? Ideally, IBM will successfully ignite growth as a software and cloud company. It's already showing some encouraging signs on that front, including in 2021's fourth quarter, when its revenue grew 6.5% year over year. Additionally, management is expecting mid-single-digit percentage revenue growth in 2022.
Shareholders shouldn't have any worries about getting paid if this performance becomes the norm. However, after a tumultuous decade during which the company shed billions in revenue, I wouldn't blame investors for approaching this stock with caution. Fortunately, IBM has an opportunity to make the next chapter of its story a better one.