Warren Buffett’s IBM Investment And Its Dividends

If you are a close follower of IBM’s stock, you know what has been the general story for the company over the past several years: IBM has been having trouble transitioning to the cloud and growing revenues because operations are so immense, but because the dividend only accounts for a little more than a fifth of profits, IBM is able to retire significant blocks of stock and increase earnings per share due to buybacks with only a soft reliance on what we would consider old-fashioned growth, at this point in time.

Because IBM is getting 9% annual growth due to lowering costs and buying back stock rather than increasing revenues at the top line, a lot of analysts have been poking fun at the stock and touting it as a bad investment.

What I find bemusing is that, over this time period, Warren Buffett has nicely benefitting from his ownership stake in IBM, despite the concerns expressed about the company in the press.

He purchased 63.9 million shares of IBM in time for his letter to shareholders in 2011, and although he increased the position to 68.1 million shares by the time of the most recent report, we will take a look at what those 63.9 million shares are doing for Buffett and Berkshire Hathaway shareholders.

In 2011, IBM was paying out $0.75 per share in dividends, which worked out to $3.00 over a twelve-month period (IBM actually has the habit of raising its dividend in May).

Those 63.9 million shares were generating $191 million in immediate dividends for Buffett to take and deploy elsewhere.

By 2012, those dividends had become $0.85 quarterly, or an annual rate of $3.40. At this point, $217 million was getting sent Buffett’s way.

Last year, IBM raised its dividend to $0.95 per share ($3.80 annually). That gave Buffett $242 million in dividends to make new investments for Berkshire.

And now, that quarterly dividend has grown to $1.10 per share, or $4.40 annually. Now, he’s collecting $281 million over the current twelve-month stretch that we find ourselves in.

Obviously, Buffett’s working with a whole lot more capital than the rest of us, but the general principles hold: The amount of money that Buffett is receiving from IBM has increased 47% since he made his initial investment in 2011. That’s what makes the fundamental performance of the business at such a disconnect from the headline risk—it’s what you saw happen to McDonald’s in the early 2000s and Johnson & Johnson in the late 2000s—the stock fell out of favor with investors while growing profits and raising the dividend significantly.

For someone not concerned with the share price and just checking in each year to make sure that the profit figures are doing all right while also collecting his dividend checks to spend, the ride has been great. How many areas of life can you achieve 47% growth in income over four years without doing anything? You could have mailed in a check for some IBM shares, completely gone through life while ignoring it and paying the taxes if not held in a retirement account, and the raises kept coming. That’s what makes this stuff fun.

It is also highlights the role that stocks like Disney, Visa, Becton Dickinson, and here, IBM, play in a portfolio. A lot of times, income investors ignore these kinds of companies because the starting dividend yield is too low. That’s understandable, but look at what lies ahead if you have the patience to wait for a couple years of dividend increases to show up.

Just between 2011 and 2014, IBM increased its payout from $3 to $4.40 while having a tough business environment. If you bought 100 shares at $150 each, you would have collecting $300 initially for a 2% yield on your invested amount. Now, you’d be collecting $440 for a 2.93% annual return on your money (you’d be across the 3% threshold if you’d been reinvesting back into additional IBM shares). In a few years, the IBM yield-on-cost will start to shift from the paltry to the respectable, and you get something for waiting for that income to rise: a nice capital gain in the form of higher share prices that will sit on their on your household’s balance sheet.

It seems the best way to handle low starting dividend yields from particular investments is to pair a low-yielder with a high-yielder. Make a Visa and BP investment simultaneously, or buy shares of GlaxoSmithKline and IBM together. That way, they give you a blended yield that works. A stock like BP gives you more immediate income than you’d otherwise expect, and a stock like Visa would provide a higher growth rate than you’d otherwise expect. It makes for a nice balanced attack. Ying. Yang.

Originally posted 2014-11-21 08:00:22.

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