In recent years, International Business Machines (IBM -1.05%) fell out of favor as tech investors turned away from the company in favor of faster-growing names.
Nonetheless, even in those times, the company proved its reliability as a dividend stock, with the payout rising for 28 consecutive years. Moreover, IBM pivoted heavily into the cloud with its $34 billion purchase of Red Hat in 2019, following that up with numerous cloud-related acquisitions and spinning off slower-growth businesses, such as the one that became Kyndryl (KD -3.23%).
As IBM continues with this transformation, it should not only drive growth in the cloud but also reinforce its reliability as a long-term dividend play.
IBM and the dividend
After its recent increase, IBM pays shareholders at a rate of $6.64 per share annually, amounting to a dividend yield of 4.7% at its current share price. This is nearly triple the 1.6% average yield for the S&P 500. Additionally, of its larger rivals, only Microsoft (MSFT 1.82%) offers a payout, but its yield of 0.9% is far below that of IBM. So, when it comes to cloud stocks, IBM is in a league of its own when it comes to dividend payments.
Admittedly, that has come at a price for long-term shareholders. The stock has risen by only 6% since it closed the Red Hat purchase in July 2019, and over the last 10 years, the stock price has fallen 20%.
However, when adding the dividend payments over that time, investors still claimed a return of more than 30% since the deal closed.
Moreover, despite a long streak of payout hikes, IBM has created a sustainable payout. In the first two quarters of this year, IBM has generated $3.4 billion in free cash flow, enough to cover the $3 billion in dividend expenses.
Why IBM may improve as a dividend stock
Also, IBM's dividend appears safe in nearly any economic environment. Even if conditions deteriorate for a time, IBM holds over $16 billion in liquidity. That cash could fund the dividend for over 10 quarters without free cash flows. The sluggish economy has slowed but not stopped cloud revenue growth for competitors, so such an outcome is unlikely.
Moreover, Fortune Business Insights forecasts the cloud computing market will grow at a compound annual growth rate (CAGR) of 20% through 2030. This implies a secular growth trend for the industry that makes a sustained industry downturn improbable.
Furthermore, conditions are on track to improve for the venerable tech giant. With IBM investing more heavily in high-growth endeavors and raising productivity, it expects $10.5 billion in free cash flow for 2023. If it meets this target, IBM will generate more than $4 billion in free cash flow not tied to its dividend costs.
Indeed, IBM's $30 billion in revenue for the first six months of this year is at approximately the same level as in the same time frame in 2022. Nonetheless, that comes at a time of lower tech spending amid a sluggish economy.
Still, the 5% yearly revenue growth in 2022 shows serves as a sign that the company's condition has improved. Yes, growth investors will probably bypass IBM stock amid the single-digit revenue growth. But if one's primary focus is income, investors should have fewer reasons to worry about a falling stock price, reinforcing IBM's appeal to dividend investors.
IBM as an income investment
IBM's ability to sustain dividend increases over 28 years shows it can produce income in times of prosperity or struggles. Indeed, IBM's legacy businesses caused it to fall behind some peers in the past.
However, IBM maintained payout hikes amid those conditions. Moreover, a move into the cloud has improved its competitiveness amid that industry's secular growth. That appears to have stopped the long-term decline in the stock price.
By buying now, investors could earn a significant cash return, and with the stock less likely to fall in value, dividend investors should be more inclined to buy this stock for income.
