At one time, International Business Machines (NYSE: IBM), better known as IBM, was the quintessential American technology company. It was known for big and consistent profits.
It’s been a long time since IBM has been on top. In fact, the stock is trading 32% lower than where it was 10 years ago. So IBM may not be the growth stock of yesteryear, but it’s still attracting income investors with its 5% dividend yield.
Can investors rely on Big Blue to continue to pay that dividend?
IBM’s free cash flow fell dramatically in 2021 and is forecast to be at just about the same level this year. In 2023, free cash flow is expected to rise.
A deeper look reveals that the free cash flow tumble in 2021 had nothing to do with earnings or revenue. In fact, both were up over the previous year. The main culprits were a larger depreciation expense in 2021 than in 2020 and a nearly $4 billion change in accounts receivable.
When most companies book a sale, they send an invoice and log the sale as revenue. That sale trickles down the income statement to produce a profit, even before the customer has paid the bill. If the invoice has not been paid by the end of the quarter or year, that cash is not included in the cash flow statement because the company has not yet received the cash. On the flip side, if a company receives cash from outstanding invoices billed in the previous quarter or year, that cash is added to cash flow even though it no longer affects revenue or earnings totals.
Each quarter and year, adjustments are made on the cash flow statement to reflect changes in receivables (money the company is owed for outstanding invoices).
In IBM’s case, in 2020, it had a $5.3 billion positive change in receivables. Last year, that number declined to $1.3 billion.
So although free cash flow declined last year, it doesn’t necessarily mean that IBM’s business is suffering. It just means IBM did a great job collecting on receivables in 2020.
This year, IBM is forecast to pay $6 billion in dividends, which comes out to 56% of free cash flow. Last year, the number was similar, at 55%. I like to see payout ratios at or below 75%, so IBM’s is well within my comfort zone.
IBM has raised its dividend every year since 1996.
Considering IBM’s low payout ratio, consistent dividend increases and solid free cash flow, there is a low risk of it cutting its dividend anytime soon.
Dividend Safety Rating: B
Good investing,
— Marc
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Source: Wealthy Retirement