A New Dividend Aristocrat Yielding Over 5%

Investors looking for high-quality dividend stocks with a long history of steady dividend growth, should focus on the list of Dividend Aristocrats. The Dividend Aristocrats are a group of S&P 500 Index companies that have increased their dividend payments for at least 25 consecutive years. It's an elite group that demonstrates resilient performance in good times or bad. Whatever the economic situation might be, investors count on these securities to generate reliable and growing income. IBM these characteristics and its recent dividend increase from $1.62 to $1.63 in 2020, marked 25 straight years of rising dividends. IBM is among the 2021 inductees to the Dividend Aristocrats list, and as an added bonus the stock has a high yield above 5%. Business Overview IBM is a global information technology company that provides integrated enterprise solutions for software, hardware and services. IBM's focus is running mission critical systems for large, multinational customers and governments. IBM typically provides end-to-end solutions. In the services business, IBM is the world's largest IT provider with a 5.5% market share. In software, IBM's software business is mostly middleware, which is the software layer that connects applications and devices to each other. In hardware, IBM sells the z15 mainframes, storage, and the Power-based servers. The company has five business segments: Cloud & Cognitive Software, Global Business Services, Global Technology Services, Systems, and Global Financing. IBM is set to split into two companies by the end of 2021: a new IBM with ~$59 billion in revenue and a New Company with ~$19 billion in revenue. The new IBM will be a Hybrid Cloud and AI company focused on software. The New Company will focus on Managed Infrastructure Services. This spinoff will further differentiate IBM from its past. IBM's revenue peaked in 2011 at $107 billion and has since been declining, sitting at $74 billion last year, as the legacy businesses have been in decline. In 2020 IBM generated $8.67 in operating earnings per share compared to $12.81 in the prior year. The expectation is for the company to generate $11 or so in EPS for 2021. Growth Prospects In the 2010 through 2019 period IBM grew its EPS by a 1.2% annualized rate. Both revenue and company-wide net profit declined by an average of 2.8% per year, while the company's profit margin held steady. The reason EPS increased was due to the share count declining by an average of 3.5% per year. This has long been a criticism of IBM, as the business has been in decline while a reduced share count gave a boost to EPS. Moving forward there are possibilities for additional growth. IBM's core operations are highly profitable, but IBM had difficulty generating growth in the past several years due to the transition to cloud and SaaS in the IT industry and IBM's late entry to this market. However, IBM is now focusing on cloud and SaaS and intends to be a major player in hybrid cloud as illustrated by its $34 billion acquisition of Red Hat. In addition, the spin-off of its Managed Infrastructure business and focus on higher growth areas could accelerate the bottom line in the future. Taking these items collectively, we are forecasting 4% annual EPS growth, coming off a somewhat subdued $11 EPS expectation for 2021. This would be more than enough growth to continue increasing its dividend each year. Competitive Advantages IBM's competitive strength is its brand, entrenched customer relations and extensive patent portfolio. IBM is also the market leader in mainframe computers where it has little competition. IBM is a recession-resistant company since the company has long-term service and maintenance contracts leading to recurring revenue and cash flows. The nature of mission critical IT enterprise systems makes this unlikely to change in the near future. However, the company does face risks in that many of its competitors have a head start in the cloud and are growing faster. During the last recession IBM posted EPS of $8.93, $10.01, $11.52 and $13.06 during the 2008 through 2011 stretch. Moreover, the dividend kept increasing as well. This time around, results have not been as resilient, with IBM posting EPS of $13.66, $13.81, $12.81 and $8.67 in the last four years. However, earnings are expected to rebound this year and the dividend has continued to increase, albeit at a slower rate. Potential Returns Future returns for IBM stock will be derived from earnings growth, the future earnings multiple of the stock valuation, and dividends. As noted above, we expect 4% annual growth in EPS over the next five years. This would lead to EPS of $13.38 in five years, off a base of $11 for 2021. When it comes to valuation, over the past decade shares of IBM have traded hands with an average price-to-earnings ratio (P/E) of 12. If we use 11 times earnings and ~$13.38 per share in expected earnings, this implies the potential for a future share price of ~$147 after half a decade. Next you have the dividends, which has taken on an increased importance with regard to shareholder returns. In 2010 IBM was paying out around 20% of its earnings in the form of cash dividends. Today the number is closer to 60%, with the $1.63 quarterly dividend -- $6.52 on an annual basis -- against ~$11 in underlying earnings power. If you assume 2% dividend growth -- much lower than in the past, but prudent considering the now much higher payout ratio -- this would imply a $7.20 annual dividend in five years and a ~54% payout ratio. Collectively you might anticipate collecting ~$35 or so in total payments. If you add together the potential share price and dividends you come to a total value of ~$182 per share. With shares presently trading near $119, this implies the potential for approximately 8.8% annual returns. Final Thoughts IBM has a storied name and business. While there are concerns -- namely declining revenue, an elevated payout ratio and uncertainty related to future growth -- there are positives as well. The legacy businesses of IBM have long been in decline, but the company is making way for faster growing opportunities. To this point, IBM is spinning off its Managed Infrastructure business to focus on growth avenues. Furthermore, the dividend increase streak is noteworthy and has now qualified the company to be in elite dividend company. When looking at potential returns, the security appears to be offering a reasonable proposition, made up of average growth coming off a subdued base, a strong 5.5% starting dividend yield and a moderate valuation. As a result, IBM is an attractive Dividend Aristocrat for income and value investors.

A New Dividend Aristocrat Yielding Over 5%

Big Blue is among the 2021 inductees to the select group of S&P 500 companies that have increased their dividends for at least 25 consecutive years.

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