Don't Race Out To Buy International Business Machines Corporation (NYSE:IBM) Just Because It's Going Ex-Dividend

International Business Machines Corporation (NYSE:IBM) is about to trade ex-dividend in the next 2 days. The ex-dividend date occurs one day before the record date, which is the day on which shareholders need to be on the company's books in order to receive a dividend. It is important to be aware of the ex-dividend date because any trade on the stock needs to have been settled on or before the record date. Accordingly, International Business Machines investors that purchase the stock on or after the 9th of May will not receive the dividend, which will be paid on the 10th of June.

The company's next dividend payment will be US$1.68 per share, on the back of last year when the company paid a total of US$6.68 to shareholders. Based on the last year's worth of payments, International Business Machines stock has a trailing yield of around 2.7% on the current share price of US$249.18. If you buy this business for its dividend, you should have an idea of whether International Business Machines's dividend is reliable and sustainable. As a result, readers should always check whether International Business Machines has been able to grow its dividends, or if the dividend might be cut.

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Dividends are typically paid out of company income, so if a company pays out more than it earned, its dividend is usually at a higher risk of being cut. International Business Machines distributed an unsustainably high 112% of its profit as dividends to shareholders last year. Without extenuating circumstances, we'd consider the dividend at risk of a cut. That said, even highly profitable companies sometimes might not generate enough cash to pay the dividend, which is why we should always check if the dividend is covered by cash flow. Dividends consumed 52% of the company's free cash flow last year, which is within a normal range for most dividend-paying organisations.

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. Still, if the company repeatedly paid a dividend greater than its profits, we'd be concerned. Extraordinarily few companies are capable of persistently paying a dividend that is greater than their profits.

See our latest analysis for International Business Machines

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

Have Earnings And Dividends Been Growing?

When earnings decline, dividend companies become much harder to analyse and own safely. If earnings decline and the company is forced to cut its dividend, investors could watch the value of their investment go up in smoke. With that in mind, we're discomforted by International Business Machines's 5.6% per annum decline in earnings in the past five years. Ultimately, when earnings per share decline, the size of the pie from which dividends can be paid, shrinks.

Another key way to measure a company's dividend prospects is by measuring its historical rate of dividend growth. In the past 10 years, International Business Machines has increased its dividend at approximately 4.3% 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 112% of its profits, and with shrinking earnings we think it's unlikely that this dividend will grow quickly in the future.

The Bottom Line

From a dividend perspective, should investors buy or avoid International Business Machines? Earnings per share have been shrinking in recent times. Worse, International Business Machines's paying out a majority of its earnings and more than half its free cash flow. Positive cash flows are good news but it's not a good combination. It's not that we think International Business Machines is a bad company, but these characteristics don't generally lead to outstanding dividend performance.

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. For example, we've found 5 warning signs for International Business Machines that we recommend you consider before investing in the business.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.