In the technology world, International Business Machines (NYSE:IBM) and Hewlett-Packard (NYSE:HPQ) are suffering similar afflictions. Both companies were once titans of industry, kings of the hardware realm. But as the smartphone revolution paved the way for more computing functions to be performed on mobile devices, personal computers and other hardware-related products faded in relevance.
Indeed, both IBM and HP are now more closely associated with corporate turnarounds rather than established industry leaders. Their share prices have stagnated over the past few years, as has their growth.
But to their credit, they both pay dividends and have raised payouts in recent years, probably in an attempt to appease shareholders while their turnarounds materialize.
From that dividend perspective, which stock is better suited for income investors?
Times are tough for IBM and HP. As PC shipments decline around the world, both companies are having trouble adapting. HP's revenue last year declined 1% year over year, and was down 7% from the prior year. IBM, meanwhile, has suffered revenue declines for 13 quarters in a row.
But for all their challenges, each stock still generates enough cash flow to pay a dividend. The first way to gauge which stock is better for income investors is through the dividend yield. IBM's forward dividend totals $5.20 per share; based on its $152 stock price, that offers investors a 3.4% yield. For its part, HP pays shareholders $0.70 per share. Its own dividend yield stands at 2.5%.
This gives IBM a significant lead on this metric. A difference of 90 basis points might not sound like much, but stated differently, IBM provides investors with 36% more income than HP, for every dollar invested. As a result, IBM has an edge over HP in terms of current dividend.
Dividend yield alone doesn't tell the whole story. A current dividend yield is a snapshot of how much income an investor will receive right now. But how much income will be earned over the course of several years is a different question. That requires a bit of guessing; fortunately, there are metrics an investor can use to help predict whether a company can grow its dividend going forward.
The first is the free cash flow payout ratio. This measure tells an investor how much of a company's annual free cash flow is being distributed in dividends, as a percentage. Last year, IBM generated $13.1 billion of free cash flow and its dividend cost $4.2 billion, for a 32% free cash flow payout ratio. Meanwhile, HP generated $8.4 billion of free cash flow and utilized $1.1 billion to pay dividends, for a minuscule 13% free cash flow payout ratio.
Both stocks have set a precedent of dividend growth. Over the past five years, IBM and HP have increased their dividends by 14% and 17% per year, respectively.
While both stocks can easily afford their dividend payouts and both have raised dividends at impressive rates, HP has a lower payout ratio and a track record of stronger historical dividend increases. As a result, it looks as though HP has the better chance of raising its dividend at higher rates going forward.
The key takeaways
In the end, IBM and HP may satisfy a different type of income investor. IBM has a significantly higher dividend yield, which may endear it to investors who prefer more income now. But HP could increase its dividend at higher rates down the road, which could make it the better pick for die-hard dividend growth investors.
Bob Ciura owns shares of International Business Machines. The Motley Fool has no position in any of the stocks mentioned. 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.