More than a century, IBM (NYSE: IBM) was a big dividend for investors. The company has paid a dividend every year since 1916 and has increased the dividend for the current 18-year series. Its current 4.7% dividend yield is tempting in low-interest environments, especially compared with the lower S & P 500 yield of 2.1%.
However, IBM faces several challenges that have hampered the company's growth in recent years. This may put pressure on the company's ability to increase the dividend ahead. Although the profitability of Microsoft (NASDAQ: MSFT) is lower, the company grows and has a lot of money to keep increasing its dividend over time.
IBM Stays With It
For several years, IBM has been gradually shifting its revenue from inherited hardware and services to areas at a faster pace such as blocs, clouds, mobile solutions and data analysis to position themselves for long-term growth. However, as he does, Big Blue is entering areas where more agile competitors have already defeated it and are well established.
This is most noticeable in IBM's cloud business (about 24% of total revenue), where Amazon.com and Microsoft ̵
Azure cloud business of Azure increased 76% in the third quarter, faster than Amazon Web Services. With every corporate client Microsoft acquires, this is a less IBM customer.
IBM does not show any signs of catching up with its competitors. Amazon and Microsoft are the rabbits in this race, while IBM is a slow-moving turtle. That's why IBM came out and spent $ 34 billion recently to buy Red Hat to buy its way to the top of the cloud, but some analysts remain skeptical about IBM's strategy.
If IBM does not grow, dividend increase will be difficult
Big Blue is trying to improve its growth for many years and failed to get the needle to move. Over the past 10 years, IBM's revenue and free cash flow from which dividends are paid have not increased, as you can see in this table. Note also that IBM's performance is a mirror image of Microsoft's steady growth.  IBM Revenue (TTM) Chart ” src=”https://media.ycharts.com/charts/22c72a1a6a059b4e60a1897039b9e773.png”/>
IBM has managed to increase dividend payout per share by 207% over the past decade, but this is due to an increase in the payout ratio of less than 20% of free cash flow to 44% in the past year. The company also artificially increased dividend per share by redemption of shares.
In addition, IBM has $ 21.5 billion in net debt on balance with another $ 15.8 billion in retirement liabilities, which may make it more difficult for the company to increase dividends. This debt level does not include the funding needed to acquire $ 34 billion in Red Hat, which will be funded by a combination of money and debt.
Better Dividend for Long Distance
In sharp contrast, Microsoft is soaked in cash, and operating results are stellar. At the end of the third quarter, the software giant had $ 59.7 billion in net money and generated $ 32 billion in free cash flow over the past year. Microsoft pays 40% of the free cash flow on dividends.
While IBM's ditch seems to be steadily declining, Microsoft enjoys a broad ditch based on its dominance with its Windows operating system as well as familiar users with its Office software. More of Microsoft's revenue comes from recurring subscription fees, such as Office 365. The software giant has seen steady growth in its leading Windows and Office products lately.
Analysts expect Microsoft to increase its revenue by 14% a year over the next five years, which is in line with the company's latest results. At this rate of growth, profits and free cash flow would increase almost fourfold over the next decade. Microsoft may increase the payment of a dividend of a pro-rata amount.
Look at the table below. Over the past 10 years, Microsoft has increased its dividend at a slightly faster pace than IBM, although Microsoft pays a little less than its free cash flow as dividends. "src =" https://media.ycharts.com/charts/57e225842a9e1ea2e69ca95bfed77426.png "/>
Successful investment in dividend growth can be very rewarding, as these dividend payments are getting bigger and harder to achieve. The structure of an incredibly large is in your favor by investing in a company that demonstrates growth in free cash flow and avoiding companies that are not.
In the long run, investors are better off investing in a broad-based Microsoft that can consistently increase earnings and profits to fund higher dividend payments over time. Microsoft offers investors both a potential increase in capital and an increase in income over time; these are two things IBM may not be able to generate for shareholders.
John Mackie, CEO of Whole Foods Market, a subsidiary of Amazon, is a member of the board of directors of The Motley Fool. Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of the board of directors of The Motley Fool. John Ballard holds Amazon shares. Motley Fool owns shares and recommends Amazon. Motley Fool owns Microsoft shares. Motley Fool recommends Gartner. The Motley Fool has a disclosure policy.