The Dividend Daily

International Business Machines (IBM) has been a tech stalwart for several decades. Here’s why it’s time for the company to get serious about its dividend — and stop wasting so much money on share buybacks.

Keeping up with the Joneses

This past May, IBM raised its quarterly dividend payout by 13%. The new payout of 85 cents, up from 75 cents previously, seemed like a decent move on the surface. With a current dividend yield of just 1.8%, however, IBM’s recent increase simply cannot compare other tech giants like Microsoft (MSFT) and Cisco (CSCO).

Software giant Microsoft, which began paying a regular dividend in 2003, recently upped its payout to 23 cents per quarter. This new payout will cost the company $1 billion annually — a small sum to keep shareholders happy. MSFT currently offers a healthy dividend yield of 3.26%.

Networking equipment maker Cisco just started paying dividends in 2011, starting with 6 cents every quarter. The dividend increased to 8 cents in 2012, and was raised 75% in August to 14 cents. The new dividend payments will cost CSCO approximately $3 billion a year. The company currently offers a 3.3% yield, which is an attractive level for dividend-minded investors.

IBM has yet to bring its dividend payout up to the level of its major tech competitors — not that the company can’t afford it.

Small Dividends, Big Buybacks

With about $12 billion in cash on the books, it’s clear that IBM could easily afford to double, or even triple its dividend. This process would be even easier if the company diverted some of the money it spends each year on share buybacks to its dividend program. In 2011, in fact, IBM bought back about $12.6 billion worth of its own shares, yet paid out only $3.5 billion in dividends.

Here at Dividend.com, it’s no secret we simply don’t like share buybacks. All too often, buybacks are used as a tool to pad a company’s earnings per share and to allow executives to cash out of lucrative stock options. Sometimes, companies even buy back shares only to reissue them to employees. For these and many other reasons, we firmly believe IBM is much better off using its excess cash to either expand its business or distribute the money directly to shareholders via higher dividends. Yet IBM plans to spend even more on buybacks in coming years.

Give Investors What They Want: Higher Dividends

IBM, due in no small part to its lowish dividend yield, has underperformed the markets in 2012. Since the beginning of the year, its stock has risen just 3%, compared with a nearly 10% gain for the benchmark S&P 500 Index (SPY). In fact, IBM’s 1.8% yield pales in comparison even to SPY’s yield of about 2.25% — and an index like SPY is hardly considered an income play.

In the current low interest rate environment, stocks with higher yields are much more attractive to many investors. Unless it raises its dividend up to par with its competitors, IBM runs the risk of continued underperformance. Without a solid yield to fall back on, stocks like IBM can quickly fall out of favor with investors looking for share price growth.

The Bottom Line

IBM may needs to adjust its strategy and join the recent movement of offering higher dividends to investors. After a big rise in share price from 2006 through 2011, IBM has been nothing but dead money over the past year. The bulk of its share price move is likely behind it.

As a mature company, it is time to stop playing the buyback game and start giving investors what they really want. For IBM to be considered a viable investment moving forward, it must demonstrate a newfound dedication to rewarding shareholders — not with buybacks, but with much healthier dividends.

International Business Machines(IBM) is not recommended at this time, holding a Dividend.com DARS™ Rating of 3.4 out of 5 stars.

Be sure to visit our complete recommended list of the Best Dividend Stocks, as well as a detailed explanation of our ratings system here.