- Truven Health acquisition and Morgan Stanley Upgrade have led to a spike in IBM share price.
- I believe robust dividend growth will continue.
- This article compares dividend income over the last 5 years to dividend income up to 2020. Investing now in IBM stock seems a smarter play.
Many analysts dismissed IBM (NYSE:IBM) in the recent past as being in a permanent bear market (dinosaur was a word they commonly used), but I have always stated that I was attracted to IBM stock at its present valuations. Well, Morgan Stanley's recent upgrade along with the $2.6 billion Truven Health acquisition definitely seem to have put a floor under the stock price for now which could indeed turn out to be an intermediate bottom. Why? Just look at the weekly technical chart. I like to look at the low stochastics as a signal of when the stock reaches overbought levels. The technical chart shows that we are nowhere near being overbought at the moment and there should be plenty more room left in this rally.
I believe the 5%+ sharp move in the stock price caught many traders and investors by surprise and with IBM's latest above-mentioned acquisition, you are now looking at a company which will have one of the biggest and diverse health clouds in the world. Furthermore, the acquisition will give IBM approximately 8500 extra clients which over time will move the needle with respect to the top line. Revenue has been the one major metric where big blue has been struggling with over the last few years. The combination of dollar strength plus the divesting of low margin businesses has produced substantial negative revenue growth in the past 5 years ($25 billion+ shaved off the annual top line since 2011). However, other key fundamental metrics have been growing meaningfully over the past 5 years ( assets on the balance sheet, dividends, etc) which make me believe that now is a better time to invest in IBM stock than 5 years ago, when the stock was clearly in an uptrend and trading at around $162 a share. (see chart below). This is what it means to be a contrarian, which is to buy into weakness and sell into strength. The herd always buys into strength which is what we had in early 2011. Contrarians buy into weakness which is what we've had since 2013 which, I believe, is the right move now.
5 years ago to the day, if you started out with an investment of $20,000 and didn't re-invest the dividend pay-outs, you would have the same amount of shares today as 5 years ago (approximately 121 shares). In 2015, this would have given the investor an annual income of $605 as the dividend pay-out for the year was $5 per share. Now this is a 72% increase in income compared to 2011 as the pay-out in 2011 was $2.95 a year which equated to an income of $357. Not bad especially as no dividends were re-invested. What would have happened if the investor re-invested every cent back into IBM stock over the last 5 years. Well, then the initial 121 share-count would have jumped to 136 which means 2015 dividend income would have been $680 (An 80% increase from 2011 levels)
So let's leave 80% as our guideline. That's the figure we have to beat in terms of income over the next 5 years. Why I believe now is a far better time to invest has mostly got everything to do with the current stock price and the number of shares we can accumulate. This stock has grown its dividend robustly every year for the last 20 years+ and although the dividend pay-out ratio is rising, dividends still make up only around a third of annual free cash flow. A $20,000 investment today can net us 150 IBM shares. For 2016, I'm expecting one quarterly dividend payment of $1.3 and three quarterly payments of at least $1.45. This means that a $20k investment this year should net $847 in dividend income in 2016. The two variables over the ensuing 5 year period are the dividend growth rate and the movement in the stock price. Let's say that the dividend growth rate is 15% (which is on par with growth rates over last few years) for the next five years and the share price gains of $10 every year. How do things work out if we re-invest dividends?
|2016 Income||150 shares x $5.65 in dividends = $847|
|2017 Income||156 shares x $6.50 in dividends = $1,013|
|2018 Income||162 shares x $7.47 in dividends = $1,211|
|2019 Income||169 shares x $8.59 in dividends = $1452|
|2020 Income||178 shares x $9.88 in dividends = $1,758|
|2020 Expected Dividend Income||$1,758|
That's an expected 108% increase in dividend income from 2016 to 2020 which is almost a 30% increase in income from 2011 to 2015. The main reason for this was due to the greater amount of shares the investor was able to accumulate in 2016 as opposed to 2011 (30 shares more for the same dollar amount investment).
To sum up, here are things you must watch out for to ensure that the example above pans out as expected. In 2015, IBM reported free cash flows of $13.23 billion which was $100 million higher than 2014 numbers. It's important that this metric remains elevated to ensure that the company continues to hike its dividend meaningfully every year. Furthermore, robust dividend growth levels don't necessarily mean growing dividend payouts because IBM has been reducing its float meaningfully over the last 5 years. In fact, the float has dropped from 1.21 billion in 2011 to 970 million shares today illustrating significant share buybacks by the company in recent times. Also, watch that the company doesn't try to leverage its balance sheet too much through more acquisitions. At the moment, IBM has over $8 billion in cash and $14 billion in equity on its balance sheet. These metrics need to remain strong to ensure that IBM can continue rewarding its shareholders.