Their revenue and earnings growth has slowed down dramatically in the past few years, which is not what most investors are accustomed to from technology stocks. But while these two aren't rewarding growth investors much, they are rewarding income investors. Even though their top-line growth has ground to a halt in recent years, IBM and HP have steadily increased their dividends along the way, because they continue to generate a lot of cash. This makes them quite appealing for income investors.
In this head-to-head match-up of two technology giants, here's which one is the better pick for income investors.
Dividend yield and sustainability
HP recently raised its dividend by 10%, to $0.704 per share annually. At its recent stock price, this bumps HP's dividend yield up to 2.24%. Still, even with the raise, HP's dividend yield is lower than IBM's. IBM yields 2.74%, about 50 basis points higher than HP.
Moreover, IBM is due to increase its own dividend soon. It's been one full year since IBM last increased its dividend, and the company typically increases its dividend in April. As a result, IBM's yield advantage over HP is only likely to widen in the coming weeks.
In terms of sustainability, both dividends appear secure. This might come as a surprise, given that neither company is growing much these days. IBM's revenue fell 3% in 2014, while HP's revenue fell slightly less than 1% last year. Despite this, both companies still generate lots of cash, which allows them to continue increasing their dividends.
HP generated $8.4 billion of free cash flow last year, which easily covered its $1.1 billion in cash dividends paid. This equates to a minuscule 13% free cash flow payout ratio. Meanwhile, IBM generated $12.3 billion of free cash flow in 2014 and paid $4.2 billion of dividends, for a 34% free cash flow payout ratio.
Therefore, the result in this category is mixed. HP gets the nod on dividend security for its lower free cash flow payout ratio, but IBM has the advantage in terms of dividend yield.
The reason neither company is growing is that both have been undone by weak demand for technology hardware.
In IBM's case, hardware revenue fell 23% last year. IBM has done a good job getting rid of certain hardware-related businesses that were barely profitable and held the company down. For example, last year, IBM sold its x86 server business to Lenovo for $2.1 billion, and also divested its semiconductor business to chip maker GlobalFoundries. In all, IBM rid itself of business operations that generated $7 billion in annual revenue but produced $500 million in pre-tax losses. This move fuels hope that IBM is on the cusp of a turnaround.
Meanwhile, HP continues to be weighed down by its large printer business. HP still derives around 20% of its annual revenue from printers. Printers aren't selling nearly as well as they used to, as HP's printing revenue fell nearly 4% last year.
IBM and HP generate enough cash flow to increase their dividends modestly each year, but lack of top-line growth is preventing them from passing through more generous dividend increases. As a result, it's likely that future dividend growth in both cases will mimic past dividend growth -- around low double digits annually. But IBM seems to have a more convincing turnaround in place, due to the divestiture of its low-margin hardware businesses. As a result, I give the nod to IBM for better dividend growth prospects.
Overall winner: IBM
The bottom line is that HP has better coverage of its current dividend, based on its stronger free cash flow than IBM. But IBM is taking the necessary, albeit costly, steps of turning its business around to better position itself for future growth. IBM is investing heavily in new technologies such as the cloud and Big Data, while HP is still chained to the personal computer and printing.
Because of its stronger dividend growth prospects going forward, as well as its significantly higher dividend yield, IBM is the better dividend stock of the two.
Bob Ciura owns shares of International Business Machines. The Motley Fool owns shares of International Business Machines. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.