Don’t Buy International Business Machines Corporation (NYSE:IBM) For Its Next Dividend Without Doing These Checks

It looks like International Business Machines Corporation (NYSE:IBM) is about to go ex-dividend in the next 4 days. Typically, the ex-dividend date is one business day before the record date which is the date on which a company determines the shareholders eligible to receive a dividend. The ex-dividend date is of consequence because whenever a stock is bought or sold, the trade takes at least two business day to settle. Accordingly, International Business Machines investors that purchase the stock on or after the 9th of August will not receive the dividend, which will be paid on the 10th of September.

The company’s upcoming dividend is US$1.64 a share, following on from the last 12 months, when the company distributed a total of US$6.56 per share to shareholders. Based on the last year’s worth of payments, International Business Machines stock has a trailing yield of around 4.6% on the current share price of $144.07. Dividends are an important source of income to many shareholders, but the health of the business is crucial to maintaining those dividends. So we need to investigate whether International Business Machines can afford its dividend, and if the dividend could grow.

View our latest analysis for International Business Machines

If a company pays out more in dividends than it earned, then the dividend might become unsustainable – hardly an ideal situation. International Business Machines paid out 111% of profit in the past year, which we think is typically not sustainable unless there are mitigating characteristics such as unusually strong cash flow or a large cash balance. Yet cash flow is typically more important than profit for assessing dividend sustainability, so we should always check if the company generated enough cash to afford its dividend. Fortunately, it paid out only 40% of its free cash flow in the past year.

It’s good to see that while International Business Machines’s dividends were not covered by profits, at least they are affordable from a cash perspective. If executives were to continue paying more in dividends than the company reported in profits, we’d view this as a warning sign. Extraordinarily few companies are capable of persistently paying a dividend that is greater than their profits.

Click here to see the company’s payout ratio, plus analyst estimates of its future dividends.

NYSE:IBM Historic Dividend August 4th 2021

Have Earnings And Dividends Been Growing?

Companies with falling earnings are riskier for dividend shareholders. If business enters a downturn and the dividend is cut, the company could see its value fall precipitously. Readers will understand then, why we’re concerned to see International Business Machines’s earnings per share have dropped 16% a year over the past five years. Ultimately, when earnings per share decline, the size of the pie from which dividends can be paid, shrinks.

Another key way to measure a company’s dividend prospects is by measuring its historical rate of dividend growth. International Business Machines has delivered an average of 9.7% per year annual increase in its dividend, based on the past 10 years of dividend payments. The only way to pay higher dividends when earnings are shrinking is either to pay out a larger percentage of profits, spend cash from the balance sheet, or borrow the money. International Business Machines is already paying out 111% of its profits, and with shrinking earnings we think it’s unlikely that this dividend will grow quickly in the future.

To Sum It Up

Should investors buy International Business Machines for the upcoming dividend? It’s not a great combination to see a company with earnings in decline and paying out 111% of its profits, which could imply the dividend may be at risk of being cut in the future. However, the cash payout ratio was much lower – good news from a dividend perspective – which makes us wonder why there is such a mis-match between income and cashflow. It’s not that we think International Business Machines is a bad company, but these characteristics don’t generally lead to outstanding dividend performance.

With that in mind though, if the poor dividend characteristics of International Business Machines don’t faze you, it’s worth being mindful of the risks involved with this business. In terms of investment risks, we’ve identified 4 warning signs with International Business Machines and understanding them should be part of your investment process.

If you’re in the market for dividend stocks, we recommend checking our list of top dividend stocks with a greater than 2% yield and an upcoming dividend.

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This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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