3 Reasons Why IBM Is a Top Dividend Stock

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Source: IBM

For dividend investors, IBM is something of a battleground stock. Over the last five years, the company has landed on income investors' radars due to CEO Ginni Rometty's capital return policies. On the other hand, many bears note the company continues to post sluggish revenue growth. However, judging IBM solely on sagging revenue is incomplete. Here are three reasons the company is a top dividend stock.

IBM's revenue growth has been downright anemic, but that's OK
IBM's revenue growth hasn't recovered from the Great Recession. From fiscal 2009 to 2013, the company only grew its top line by 1% --less than the rate of inflation during that period. Investors should look for revenue growth to continue to grow sluggishly or not at all. Key here is IBM's sale of its x86 server business to Lenovo for $2.3 billion.

The divestiture gives IBM the potential to concentrate on higher-margin businesses (more on that later), but will decrease revenue. The company said the business delivered approximately $4.6 billion in revenue in the last fiscal year, over 4.6% of IBM's near-$100 billion revenue haul.

For what it's worth, IBM said the business was only breakeven on a pre-tax basis. It is apparent the company is looking to shed low-margin businesses to focus on higher-margin cloud and enterprise computing solutions.

The cloud is working for IBM
IBM's continued transition to the cloud business appears to be going well. After buying SoftLayer in 2013 for $2 billion, the company quickly transitioned customers to the platform. The purchase and subsequent moves have paid off: IBM's cloud-based revenue jumped 86% in its last quarter from the year prior.

In fact, the company has taken the cloud services world by storm. Gartner upgraded IBM in its May "magic quadrant" report to visionary from niche player based on completeness of vision. The company also increased in Gartner's other ratings classification: ability to execute.

IBM hasn't reported a cloud computing division revenue figure so far in 2014. But it has noted that cloud-based revenue was on track to be 50% higher in 2014 than 2013. Since cloud-based revenue in 2013 was $4.4 billion, IBM should gross more than $6 billion in cloud-based revenue in this fiscal year.

Each share's increasing value
During that same period (2009-2013), IBM increased its net income by roughly 5.3% per year. That's better than its revenue growth, and proof the company is investing in higher-margin businesses and/or cutting costs prudently. However, during that period, earnings per share increased nearly 50%, or 10.4% a year. The reason: rapid share buybacks. The chart below gives proper context:

Source: IBM's 10-Ks. All figures are in millions. Left Y-axis denotes dollar figures and right Y-axis are shares outstanding.

Here's where IBM's shareholder-focused management comes into play. As you can see, the company has engaged in a rather aggressive capital return policy. Since 2009, it has given back over $80 billion to shareholders, with $64 billion coming via share repurchases. The end result is a company that has reduced its shares outstanding by nearly 18%.

A reduced share count helps income investors in two distinct ways. First, a company can increase its per-share payout faster than total dividends paid due to fewer shares outstanding. Fewer shares also help EPS growth by lowering the total number of shares outstanding. 

Final thoughts
Is IBM's lack of revenue growth concerning? Yes. However, judging IBM solely on the basis of lack of revenue growth does not tell the whole story. Right now, the company is focusing on higher-margin businesses and continuing to enrich shareholders by its shareholder-focused stock buyback. IBM will eventually grow its top line, but with high-margin cloud revenue rather than low-margin hardware revenue.

Top dividend stocks for the next decade
The smartest investors know that dividend stocks simply crush their non-dividend paying counterparts over the long term. That's beyond dispute. They also know that a well-constructed dividend portfolio creates wealth steadily, while still allowing you to sleep like a baby. Knowing how valuable such a portfolio might be, our top analysts put together a report on a group of high-yielding stocks that should be in any income investor's portfolio. To see our free report on these stocks, just click here.

The article 3 Reasons Why IBM Is a Top Dividend Stock originally appeared on Fool.com.

Jamal Carnette has no position in any stocks mentioned. The Motley Fool recommends Apple and Gartner. The Motley Fool owns shares of Apple and 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.

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