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It Might Not Be A Great Idea To Buy International Business Machines Corporation (NYSE:IBM) For Its Next Dividend

It looks like International Business Machines Corporation (NYSE:IBM) is about to go ex-dividend in the next 4 days. You can purchase shares before the 9th of February in order to receive the dividend, which the company will pay on the 10th of March.

International Business Machines's next dividend payment will be US$1.63 per share, on the back of last year when the company paid a total of US$6.52 to shareholders. Looking at the last 12 months of distributions, International Business Machines has a trailing yield of approximately 5.5% on its current stock price of $119.12. Dividends are a major contributor to investment returns for long term holders, but only if the dividend continues to be paid. That's why we should always check whether the dividend payments appear sustainable, and if the company is growing.

See our latest analysis for International Business Machines

Dividends are typically paid from company earnings. If a company pays more in dividends than it earned in profit, then the dividend could be unsustainable. Last year, International Business Machines paid out 105% of its income as dividends, which is above a level that we're comfortable with, especially if the company needs to reinvest in its business. A useful secondary check can be to evaluate whether International Business Machines generated enough free cash flow to afford its dividend. Fortunately, it paid out only 38% 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. Very few companies are able to sustainably pay dividends larger than their reported earnings.

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

historic-dividend
historic-dividend

Have Earnings And Dividends Been Growing?

When earnings decline, dividend companies become much harder to analyse and own safely. 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 15% a year over the past five years. Such a sharp decline casts doubt on the future sustainability of the dividend.

Another key way to measure a company's dividend prospects is by measuring its historical rate of dividend growth. Since the start of our data, 10 years ago, International Business Machines has lifted its dividend by approximately 9.6% a year on average. That's intriguing, but the combination of growing dividends despite declining earnings can typically only be achieved by paying out a larger percentage of profits. International Business Machines is already paying out a high percentage of its income, so without earnings growth, we're doubtful of whether this dividend will grow much in the future.

The Bottom Line

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 105% 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. Overall it doesn't look like the most suitable dividend stock for a long-term buy and hold investor.

With that being said, if you're still considering International Business Machines as an investment, you'll find it beneficial to know what risks this stock is facing. Every company has risks, and we've spotted 3 warning signs for International Business Machines you should know about.

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.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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