International Business Machines (IBM 0.16%) is one of Wall Street's oldest technology companies. It was a powerhouse in the early days of mainframe computing. Today, IBM focuses on hybrid cloud systems, artificial intelligence, analytics, and consulting.
But time hasn't been kind to IBM's shareholders. The stock trailed the broader market over the past decade, turning a $10,000 investment in 2013 into just $9,563 today. That includes dividends -- take them out, and the stock is down 36%.
But as they say, past performance doesn't guarantee future outcomes. So, is IBM a declining business, or should you buy this potential comeback story? Here is what you need to know.
Why IBM has struggled
IBM's market has changed dramatically over the past decade. Enterprises are steadily shifting from on-premise computing and networking to the cloud, renting these resources instead. IBM has evolved its business over the years to keep up with the times, and there are recent signs that some of its key segments are growing.
However, zooming out helps explain why IBM's struggled to generate value for shareholders for some time now. Below, you'll see IBM's return on invested capital. In other words, when IBM puts a dollar of capital into its business, how much profit is coming out the other side? That's declined steadily over time, from more than 24% a decade ago to the low single digits.
IBM Return on Invested Capital data by YCharts
Ideally, a company generates tons of profits without too much heavy lifting, but that's not IBM today. The heavy lift required to make meaningful profits is a drag on IBM's financial performance and investment returns.
Is IBM's 5% dividend a problem?
IBM's redeeming quality over the past decade has been a generous dividend that management keeps raising. The dividend yields 5% at the current share price and has enjoyed 27 consecutive increases.
The dividend payout ratio is 70% of cash flow, so investors shouldn't fear a cut anytime soon. But should IBM prioritize its dividend? Dividends are a way that companies share profits with investors, often because they don't have a more beneficial use of the capital. If a company could reinvest that capital back into the business and generate a high return, it probably wouldn't pay a dividend in the first place.
IBM Cash Dividend Payout Ratio data by YCharts
The problem is that IBM's dividend ties up most of its cash flow, financially handcuffing a company that's struggling to grow as it is. The dividend itself doesn't benefit the company, only the shareholders. The dividend wasn't a problem when IBM was performing at a high level, but the last decade made IBM look like a slowly dying fossil that investors are milking while they can.
So what should investors do?
The current market leaves investors in a bit of a tough spot. Income-starved investors can get competitive yields from short-term Treasury bonds without the risk of losses if they hold them until maturity. Meanwhile, IBM's inefficiency with capital could plague its operating performance and limit the stock's upside until there's a notable improvement.
Given that, IBM probably isn't worth holding in a long-term portfolio until the fundamentals improve. Perhaps new CEO Arvind Krishna, who took over three years ago, can right the ship, but the stock doesn't warrant a leap of faith. Make IBM earn its spot in your portfolio.
