IBM [IBM Trend] is one of those stocks that I didn’t think I’d get to own because of its low yield, but in the past 5 days the stock price has dropped 11%, so I was able to initiate a position with a dividend yield of 2.7%. I typically like to invest in companies with a dividend yield of at least 2.5%. Going back to 1999 there have only been two years where the highest dividend yield was above 2.5%. In 2008 the highest dividend yield was 2.7% and in 2009 it was 2.6%. To be able to buy in at a yield level similar to when the financial crisis was going on, is enticing. While 2.7% isn’t the highest dividend yield, it is high for IBM. Take a look at chart below and you can see that historically this is a high dividend yield.
Yield isn’t the only value metric that looks enticing for IBM, its P/E is currently 10.2 according to MorningStar. Not to mention Warren Buffet is an investor having purchased shares a few years ago around $170. It feels good to buy in at prices below one of the all-time great investors.
I’ve talked a bit about why IBM appears value priced, but I should also probably talk about what is causing these deflated prices. The price dropped because IBM lowered their guidance and came out with lower than expected earnings. In the past management was targeting $20 of EPS in 2015, but they no longer think this is possible. While the latest quarter was disappointing I took this disappointment as an opportunity to buy IBM at deflated prices. I purchased shares on October 22, 2014 for $162.54 + commission.
I think there are some valid worries about revenue growth, but I think the good outweigh the bad in this case. For instance Valueline is estimating annual dividend growth of 9% for the next 3 to 5 years.
Here are the bullets of why I purchased IBM:
- 5 and 10 year dividend growth rates of 14.3% and 19.4% according to David Fish’s September 30, 2014 US Dividend Champions list.
- Sustainable growing dividend with a payout ratio around 30% and a dividend streak of 19 years.
- Strong financial strength. Valueline has an A++ financial strength for IBM.
- History of increasing earnings and dividends at double digit rates.
- The stock appears value priced.
- Wide economic moat according to MorningStar.
I struggled a bit with this purchase because I’m using the Smith Manuever which means I’m borrowing to invest. My interest rate is 3.25% so the starting dividend yield is below this. Long term I expect the dividend to grow and my yield on cost will grow above the interest rate. My portfolio as a whole will include a mix of lower and higher yield stocks that will likely end up with a portfolio yield of around 3-4% based on the type of stocks I invest in. Investing in technology stocks when you plan to hold onto the stock for forever can be risky because technology changes at a rapid pace, but IBM has shown it has the ability to pivot well in a changing landscape. At the end of the day while certain things about IBM make me nervous, I’m content with my investment. IBM has a strong dividend growth history that I expect to continue sustainably, a wide moat, strong financial strength, and the stock appears to be on sale. These are the markings of a good dividend growth investment, which is why I bought shares.
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