Forget IBM. Microsoft is a better dividend growth stock – The Motley Fool

For more than a century, IBM (NYSE: IBM) has been a major dividend stock for investors. The company has paid dividends every year since 1916 and has increased the dividend for a current stretch of 18 years in a row. Its 4.7% current dividend yield is tempting in a low-interest environment, especially compared to the lower S&P 500 return of 2.1%.

However, IBM faces several challenges that have made it difficult for the company to grow in recent years. This can put pressure on the company's ability to increase dividends in the future. Although Microsoft s (NASDAQ: MSFT) the yield is lower, the company grows and has a lot of money to continue to increase its yield over time.

  A plant that grows out of a bunch of coins with a city skyline in the background.


IBM is left behind

For several years, IBM has shifted its revenue from older hardware and services to faster-growing areas, such as blockchain, cloud, mobile solutions, and data analysis to position itself for long-term growth. As it does, Big Blue comes into areas where several scary competitors have already beaten it and are well grounded.

This is most notable in the IBM cloud industry (about 24% of total revenue), where the Company is far away and Microsoft ̵[ads1]1; the top two market leaders. More and more companies are moving the entire computer systems to the cloud. Amazon has achieved the top spot in the cloud market with 52% market share, according to research firm Gartner . Microsoft was late to the cloud market, but caught fast, earning the second place behind Amazon with a 13% market share. Meanwhile, IBM has only managed to capture 2% of the market.

Microsoft's Azure cloud business increased its revenue by 76% year-on-year in the third quarter, faster than Amazon Web Services. With every business customer, Microsoft picks up, it's a smaller customer for IBM.

IBM shows no sign of catching up with its rivals. Amazon and Microsoft are the hares of this race, while IBM is the slow turtle. Therefore, IBM went out and recently spent $ 34 billion to buy Red Hat to buy its way to the top of the cloud, but some analysts are still skeptical of IBM's strategy.

If IBM does not grow, yield increases will be difficult

Big Blue has been trying to improve growth for many years and has not managed to get the needle moving. Over the past 10 years, IBM's revenue and free cash flow – of which dividends are paid – has not grown, as you can see in this chart. Also note how IBM's operating performance is a reflection of Microsoft's steady growth.

 IBM Revenue (TTM) Chart

Data from IBM Revenue (TTM) by YCharts.

The challenges facing IBM are so serious one analyst said unbelievably that Big Blu's earnings are in an "irreversible structural decline." Many other investors seem to have the same perception, and therefore IBM's shares deal with such a low price-to-earnings ratio and provide such a high dividend yield. Analysts expect the company to increase revenue only 0.96% over the next five years.

IBM has managed to increase 207% share dividend over the past decade, but this is due to an increase in payout ratio from less than 20% of free cash flow to 44% over the past year. The company also artificially increased its dividend per share by repurchasing shares.

In addition, IBM has a net debt of $ 21.5 billion in the balance sheet with an additional $ 15.8 billion in pension liabilities, which can make it difficult for the company to increase its dividends in the future. That level of debt does not include the funding required for the $ 34 billion Red Hat acquisition, which will be funded by a mix of cash and debt.

A better dividend stock for long distance

In strong contrast, Microsoft sails in cash and the operating profit has been strong. At the end of the third quarter, the software giant had $ 59.7 billion of net cash and generated $ 32 billion of free cash flow over the past year. Microsoft pays out 40% of the free cash flow in dividends.

Metric IBM Microsoft
Cash $ 14.5 billion $ 136 billion
Debt $ 47 billion $ 76 billion
Revenue (TTM ) $ 12.7 billion $ 32 billion
Dividend yield $ 12 billion $ 115 billion $ 115 billion
Net profit (TTM) $ 5.7 billion $ 19 billion
19659024] 4.7% 1.7%
Dividend payout as a percentage of free cash flow 44.2% 40.4%
Forward price-to-earnings ratio 8.75 20.93 19659047] Data source: Companies, Y-Charts and Yahoo! Finance. TTM = subsequent 12 months.

While IBM's moat appears to shrink steadily, Microsoft has a broad moat based on dominance with its Windows operating system, and the well-known users have their Office software. Several of Microsoft's revenues come from repeated subscription fees, such as Office 365. The software giant has seen steady growth in its flagship Windows and Office products lately.

Analysts expect Microsoft to increase earnings by 14% per year over the next five years, which is in line with the company's latest performance. With this growth rate, profits and free cash flow will be almost four times over the next decade. Microsoft can increase the dividend with a proportionate amount.

Take a look at the chart below. Over the past 10 years, Microsoft has increased its yield a little faster than IBM, even though Microsoft pays slightly less of the cash flow as a dividend.

 IBM Dividends Paid (TTM) Chart

IBM Dividend Paid (TTM) data from YCharts.

IBM's dividend increases were made by increasing the payout as a percentage of free cash flow, while Microsoft partially increased its dividend through free cash flow growth, which is ideally which dividend investors will look for.

Successful dividend growth investing can be very rewarding down the road, as these dividends are getting bigger and bigger, and it's not difficult to achieve. You stack your odds tremendously to your advantage by investing in a company that has shown growth in free cash flow and avoiding companies that don't.

In the long run, investors are better off investing in broadband Microsoft, which can consistently increase revenue and profits to fund higher dividend payments over time. Microsoft offers investors both potential capital growth and increasing revenue over time; There are two things that IBM may not be able to generate for shareholders.

John Mackey, CEO of Whole Foods Market, a subsidiary of Amazon, is a member of The Motley Fools Board. Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fools Board. John Ballard owns shares in Amazon. Motley Fool owns and recommends Amazon shares. Motley Fool owns shares in Microsoft. Motley Fool recommends gardener. Motley Fool has a disclosure policy.

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