Is IBM Becoming a Dividend Growth Stock?

International Business Machines (IBM -8.25%) has now increased its dividend for the 19th year in a row with the recent announcement of a 16% dividend hike. Following another quarter where revenue declined due to the weak hardware business, this sizable dividend boost is certainly good news for investors, and it puts IBM closer to becoming a solid dividend growth stock.

Dividend growth, but buybacks are still king
The most recent 16% dividend increase, which puts the quarterly dividend payment at $1.10 per share, is the largest increase since 2010. IBM now sports a forward dividend yield of about 2.25% based on this new dividend. That's low compared to other big tech companies like Microsoft (MSFT -2.45%) and Intel (INTC 1.77%), but higher than what IBM has historically paid investors.

Microsoft has a dividend yield of about 2.75%, although this has been pushed down considerably over the past year as shares of Microsoft have surged. Intel pays a dividend yielding 3.4%, far higher than either IBM or Microsoft, but dividend growth going forward is threatened by stagnating profits due to Intel's push into mobile.

One reason why IBM's dividend yield is still so much lower than other big tech companies is the company's appetite for share buybacks. IBM is a prolific purchaser of its own shares. From 2009 through 2013, IBM spent more than 3.5 times as much on share buybacks as it did on dividend payments.

This preference is a double-edged sword for dividend investors. On the one hand, money spent on share repurchases is money that isn't spent on dividends. But on the other hand, share repurchases reduce the share count, allowing the company to boost per-share dividend payments at a faster rate. IBM has reduced its share count by 35% since the end of 2004, and this has helped drive more than a six-fold increase in per-share dividend payments, including the most recent increase.

Is IBM a dividend growth stock?
A good dividend growth stock needs a decent yield and the potential for significant dividend growth. IBM's yield is well below its peers, but dividend growth potential at least partially makes up for it. In 2013, dividends represented just 25% of the company's net income. Even if profits stagnate, expansion of this payout ratio along with the reduction of the share count from share repurchases can drive double-digit annual dividend increases for years to come.

Here's a dividend comparison between IBM, Microsoft, and Intel:

Dividend growth for all three companies can come from three places: growing the payout ratio, share buybacks, and earnings growth. IBM has the most room to grow the payout ratio, paying out just a quarter of its net income to shareholders, and its aggressive share buyback program helps the cause. And while IBM is struggling to grow revenue, this is the result of a weak hardware business, and the company's ability to grow profits going forward depends far more on its software and services businesses. Both not only grew revenue last quarter, but margins increased as well, and with IBM's push into the cloud and divestiture of certain hardware businesses, IBM should have the ability to grow earnings despite slumping revenue. IBM's revenue has barely increased over the past decade, but net income has nearly doubled, and EPS has more than tripled.

Intel has the highest yield of the three, but it also has the highest payout ratio, and dividend growth over the next few years is unlikely to be substantial. Earnings growth at Intel is being dragged down by the company's aggressive efforts in the mobile market, with Intel subsidizing its tablet chips in an effort to gain market share. Intel's mobile segment is losing more than $3 billion per year, and these losses won't reverse until Intel has won significant market share in both the tablet and smartphone markets. This is years away, and until then, meaningful dividend growth is unlikely.

Microsoft has a higher yield than IBM while also having the potential for rapid dividend growth. That makes Microsoft a better dividend growth stock than IBM. Microsoft only pays out 36% of its net income as dividends, and the continued strength of its product portfolio -- particularly its enterprise offerings -- means that both revenue and earnings should grow at a healthy clip. In the most recent quarter, Microsoft reported double-digit growth in many of its enterprise products, and revenue from its cloud-based offerings like Office 365 and Azure more than doubled.

The bottom line
While IBM's dividend looks a lot better than it did a few years ago, the low yield compared to other big tech companies means that there are better options for dividend growth investors. Microsoft looks more attractive, with a higher yield and similar growth prospects

While IBM has accelerated its dividend increases lately, it's still not quite enough. Both IBM and Microsoft are inexpensive based on P/E ratios, but for dividend investors, there are better options than IBM.