Why This Overlooked Tech Giant Could Be an Opportunity
The market hasn’t been very income-investor-friendly for a quite a while. Due to the Federal Reserve’s low-interest-rate policy after the Great Recession, fixed income products haven’t yielded much in the past decade. And just as interest rates began to rise, a pandemic took the world by storm.
With words like “unprecedented” and “extraordinary” being constantly used to describe the current economic situation, it’s safe to say we won’t be getting any rate hikes anytime soon.
It’s yet to be seen how the extremely dovish stance from the U.S. central bank will boost the economy, but low interest rates have certainly accomplished one thing: increased the demand for stocks. Even though most businesses are far from making a full recovery, the stock market quickly bounced back and has been soaring to new heights.
A by-product of the market rally is that, on average, the dividend yield is much lower. How much lower? Well, for most of the last decade, S&P 500 companies had an average dividend yield around two percent. Today, it’s at just 1.5%. (Source: “S&P 500 Dividend Yield,” multpl.com, last accessed January 27, 2020.)
Historically, the average dividend yield of S&P 500 companies has been a much more generous 4.3%.
The situation is more pronounced if you look at the red-hot tech sector. It’s not only because many tech stocks have shot through the roof; it’s also because some tech companies do not pay any dividends at all.
And that, dear reader, is why IBM (NYSE:IBM) could be special.
IBM is one of the oldest tech companies in the market, with a history that can be traced all the way back to 1911. Of course, in the fast-changing tech world, legacy tech companies don’t always get much attention. And that seems to be the case with IBM stock. Over the past 12 months—a period of market euphoria—the stock actually slipped by about 14%.
While that means IBM is probably not on the radar of most “Robinhood” traders, the inverse relationship between dividend yield and stock price means IBM offers something that’s rarely found in today’s tech sector: a generous cash payout.
You see, IBM stock pays cash dividends usually on the 10th of March, June, September, and December of each year. The company’s quarterly payout currently stands at $1.63 per share. With its stock trading at $118.85 per share at the time of this writing, that quarterly rate comes out to an annual yield of 5.5%.
In other words, with this mega-cap tech stock, investors can actually earn a yield that’s more than three times as high as the benchmark index’s average.
Of course, there’s usually a reason why a stock is overlooked. In the case of IBM stock, the latest pullback in its price was triggered by an earnings report.
On average, Wall Street analysts expected the company to report $20.7 billion of revenue and earnings of $1.79 per share for the fourth quarter of 2020. In reality, IBM generated $20.4 billion of revenue for the quarter, while its adjusted earnings came in at $2.07 per share. (Source: “IBM Reports 2020 Fourth-Quarter and Full-Year Results,” IBM, January 21, 2021.)
In other words, the company narrowly missed analysts’ top-line estimate and actually beat on the bottom line. In the trading session following the news release, IBM stock closed down 10%.
There was, however, some growth in the legacy tech giant. Notably, the company generated $7.5 billion in cloud revenue in the fourth quarter, which represented a 10% increase year-over-year. In full-year 2020, the company’s cloud revenue rose 19% year-over-year to $25.1 billion.
While there are tech companies with a bigger presence in the cloud market, the secular tailwind in the industry should continue to drive growth in IBM’s cloud segment.
Furthermore, the company has been generating ample cash flow to cover its oversized dividend payments. Last year, IBM generated $10.8 billion in free cash flow and returned $5.8 billion to shareholders in the form of dividends. While the company has not issued specific guidance on revenue and profits for the current year, management expects the company to earn $11.0 to $12.0 billion of adjusted free cash flow in 2021. That should be plenty to allow the company to continue dishing out juicy dividends.
In the company’s earnings conference call, IBM’s chief financial officer, Jim Kavanaugh, said, “So we’ve got firepower here that gives us the financial flexibility to continue to invest in our business, de-lever to get back to our targeted leverage ratios and also support that secured and modestly growing dividend.” (Source: “International Business Machines Corporation’s (IBM) CEO Arvind Krishna on Q4 2020 Results – Earnings Call Transcript,” Seeking Alpha, January 21, 2021.)
That’s right: even though IBM may not be known for its growth these days, its cash payouts have been on the rise. Over the last five years, the company’s quarterly dividend rate has increased by 25.4%. (Source: “Cash Dividends,” IBM, last accessed January 27, 2021.)
Bottom Line on IBM Stock
And there you have it. If you’re looking for a ticker that could shoot to the moon, IBM is probably not going to get the job done.
But for those who want to earn a safe and steadily increasing stream of dividends, IBM’s 5.5% yield surely deserves a look.