IBM Dividend – Growing Or Slowing?

By Chad Henage - May 8, 2012 | Tickers: IBM, MSFT, ORCL | 0 Comments

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In a recent article by fellow Fool Joe Tenebruso, he pointed out several companies that were growing their dividends by 20% or more in the last 5 years. If these companies keep up this pace, their dividend would double about every 3.5 years. This impressive rate of growth would not only give a boost to the stock price, but would increase investors income each year by a significant amount. One such company he mentioned was IBM (NYSE: IBM), with a growth rate of 21.4% in the last 5 years. With this large a rate of increase the question is, can this type of growth last?

Actually the first question that needs to be answered is, can the company afford its current dividend? I've seen examples of companies that increased their dividend faster than their earnings growth, and they had to stop the dividend increases or cut the dividend. Where IBM is concered, their current yield is 1.66%, with an annual payout of $3.40 per share. IBM has the ability to continue to pay this dividend easily, given that last year, the company's free cash flow payout ratio was just about 22%. However, look at what has happened to the free cash flow payout ratio in the last three years:

You can see that this percentage has increased from just over 16% three years ago, to nearly 22% with the current indicated dividend. This isn't troublesome yet, as the payout ratio is still very low. 

So if IBM can afford the current dividend, can the company keep increasing the dividend by 20%+ year after year? Take a look at the dividend growth in the last 10 years:

You can see that since 2006, when the dividend was increased 50%, that the track for dividend increases has been in a steady decline. Actually, including the most recent dividend increase, the average of the last 5 increases has been 16.38%. So technically speaking, IBM has already dropped off of this list of companies increasing their dividend 20%+ in the last 5 years. What IBM decides to do from here depends a lot on whether you believe analysts projections of growth. The average analyst expects IBM to grow earnings by about 10.5% in the next 5 years. If the company manages to grow free cash flow by say 10%, then IBM could increase the dividend 20% per year. Projecting out to 2017, the free cash flow payout ratio would still only be 33%. However, in the last three years, IBM has grown earnings by 12.42%, yet free cash flow has actually gone down. If you assume flat free cash flow and a 20% dividend increase, in five years the cash payout ratio would still just be 54%. Since IBM's capital expenditures have been relatively consistent, if this trend continues a 54% payout ratio still is relatively low. That being said, many technology companies like to keep their payout ratio low to afford the ability to make share repurchases, or earnings positive acquisitions. 

Just to give you an idea of the industry dynamic when it comes to dividends, look at Oracle (NASDAQ: ORCL) and Microsoft (NASDAQ: MSFT). Specifically, let's compare expected growth and dividend growth across the three companies.

(Free Cash Flow Payout Ratio is based on the last full year of cash flow statement for each company) 

You can see the trend that I mentioned of low payout ratios. Of these three companies, IBM seems to have the best mix of yield, dividend growth, and expected growth. While Big Blue's dividend growth has definitely slowed in the last several years, I would expect somewhere around 10-15% dividend growth going forward. This would allow the company to keep a relatively low payout ratio, and still reward shareholders nicely. I think the days of 20%+ increases are gone, but 10-15% dividend growth I'm sure is more than enough to keep IBM shareholders happy.

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