Broadcom Vs IBM Stock: The Better High Yield Tech Buy (NASDAQ:AVGO)

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The technology industry is not typically known for paying out attractive dividends. Instead, most technology companies invest aggressively in growth, so virtually all earnings are retained and reinvested in research and development, hiring, and/or sales & marketing in order to grow the business as rapidly as possible. As a result, popular technology ETFs like Ark’s flagship disruptive innovation ETF (ARKK) and the most popular Nasdaq proxy (QQQ) both offer very meager dividend payouts:

Data by YCharts

However, there are still several technology stocks that pay out attractive and growing dividends, including several blue-chip businesses. Two that we will compare side-by-side in this article are International Business Machines Corporation (NYSE:IBM) and Broadcom Inc. (NASDAQ:AVGO).

#1. Track Record

Both businesses have long and illustrious dividend growth track records.

AVGO has grown its dividend for 11 consecutive years and has achieved enormous dividend growth and total returns over that time span, absolutely crushing the dividend growth and total return performance of the S&P 500 (SPY):

Data by YCharts

Meanwhile, IBM has grown its dividend for more than twice as long, posting 27 years of consecutive dividend growth and thereby earning the coveted status of Dividend Aristocrat. While not quite as impressive as AVGO’s, IBM has still outperformed the SPY’s total return and dividend growth numbers by a hefty margin:

Data by YCharts

That said, it has struggled to generate attractive returns over the past decade, with the SPY leaving it in the dust:

Data by YCharts

A big reason for this is simply that IBM has been in transition mode away from its declining legacy businesses and towards its growth businesses. The company appears to have finally made that turn, which explains why year-to-date it is significantly outperforming SPY:

Data by YCharts

#2. Business Strength

AVGO’s business has evolved a lot over the years, thanks in large part to its aggressive M&A strategy as part of the company’s drive to be a consolidator. Today, it has established itself as a leader in the semiconductor space and also has a growing infrastructure software business that includes CA Technologies, Symantec’s Enterprise business, and its recently announced pending deal to acquire VMware. These software businesses provide it with more stable recurring revenue, which nicely balances out its more cyclical semiconductor business.

One of Broadcom’s main clients is Apple (AAPL) with roughly one-quarter of its sales coming from the sale of high-end smartphones, and it should benefit from 5G growth in this sector. On top of that, AVGO boasts leading positions in various switches and chips. AVGO is investing aggressively to sustain its market leadership through research and development to constantly improve the capabilities of its products, and also using accretive and strategic acquisitions to bolster its capabilities while unlocking synergies.

While AVGO’s results thus far have been nothing short of incredible, the business is not risk-free. First and foremost, while AAPL is a great customer to have, relying on it for a very large percentage of total sales poses concentration risk. The semiconductor industry is also notoriously cyclical, so despite the stellar results that the company has been posting lately, this could all change, though its software businesses should make the revenue more stable.

Meanwhile, IBM is a leading global IT business that enjoys a strong competitive positioning in areas like mainframes, cloud computing, and data management. While IBM’s world-class offerings and high switching costs made its revenues quite sticky, some of that is changing with the rise of open-source software and enterprise cloud services.

Nevertheless, IBM generated impressive Q1 results that included 11% overall revenue growth and 17% year-over-year growth in hybrid cloud revenue. The software business saw annual recurring revenue grow by 9% year-over-year and overall revenue increase by 15%. The consulting business saw 17% revenue growth, with double-digit revenue growth across all categories. The IT Infrastructure business saw flat year-over-year performance. Management also issued guidance for 2022 revenue growth to come in at a mid-single digit level with free cash flow at $10-$10.5 billion, giving the business plenty of financial flexibility to pay its dividend and reinvest in innovation.

#3. Balance Sheet

IBM’s balance sheet remained in good shape after Q1 with $10 billion in cash on hand, combining with its robust free cash flow generation to give it plenty of leeway for allocating capital. When combined with its stable and even growing business model, its A- (stable outlook) credit rating from S&P seems quite justified.

AVGO also has a solid balance sheet, though its BBB- (positive outlook) credit rating is not nearly as impressive. It has over $9 billion in cash on hand as of the end of Q1 with an additional $3.1 billion in accounts receivable. On top of that, its EBITDA/Interest expense ratio is a very conservative 9.56x while its current ratio is a stellar 2.14x, implying little risk of distress here.

#4. Growth Potential

Moving forward, IBM is expecting to finally see earnings per share pick up from its trough that likely happened in 2021. The company has finally successfully shifted the narrative away from its declining legacy businesses and its growthier software, infrastructure, and consulting businesses are expected to drive solid mid-single digit growth for years to come. However, dividend per share growth has slowed to a crawl and is expected to remain low at just a 2.1% dividend per share CAGR forecast through 2026. Buybacks – once a big deal for the company – have gone by the wayside as the company’s payout ratio has become elevated and its need to invest aggressively to return the company to growth has squeezed funds away from buybacks. As a result, in recent years the share count has actually increased:

Data by YCharts

Meanwhile, AVGO’s growth outlook appears largely dependent on the fate of the semiconductor industry. Analysts expect it to compound normalized earnings per share at a 7% annualized clip through fiscal 2026 and grow its dividend per share at a similar rate. This will be driven by a combination of organic business growth, new innovations and acquisitions, and share repurchases. AVGO is executing aggressively on that front, announcing on their most recent earnings call:

Consistent with our commitment to return excess cash to shareholders, we repurchased $2.8 billion in common stock and eliminated $514 million of common stock for taxes due on vesting of employee equity, resulting in the elimination of approximately 6 million AVGO shares. The non-GAAP diluted share count in Q2 was 441 million…we expect to generate considerable free cash flow. As it relates to the buyback, we have $3 billion remaining under the current authorization to date. In addition, we are announcing today an incremental $10 billion authorization to buy back shares through the end of December of 2023.

The company is clearly buying back shares hand-over-fist and plans to continue doing so over the next year or so at a minimum. This should provide a strong tailwind to earnings on top of the organic and M&A related growth.

#5. Valuation

AVGO looks attractively priced after the recent pullback in the share price, with it trading at discounts to its 5-year averages on an EV/EBITDA, Price to Earnings, dividend yield, and free cash flow yield basis:

Metric Current 5-Yr Average
EV/EBITDA 10.44x 11.30x
P/E 12.31x 14.15x
Div Yield 3.57% 3.38%
FCF Yield 9.14% 7.94%

What makes this discount look even more appealing is the fact that AVGO has become better diversified over that span, so its cash flows moving forward should be even higher quality than they were over the past half decade. This gives AVGO some margin of safety in case it fails to meet its growth expectations in the coming years as well as some multiple expansion potential if it can continue to deliver strong growth.

IBM, meanwhile, looks a bit pricey relative to its 5-year averages:

Metric Current 5-Yr Average
EV/EBITDA 10.57x 8.98x
P/E 13.87x 11.15x
Div Yield 4.67% 4.80%
FCF Yield 8.82% 9.88%

That said, this is a bit misleading as over the past five years IBM has been seeing its revenues decline and has just appeared to turn the corner and return to solid growth. While AVGO still has cheaper multiples on a head-to-head basis relative to IBM (other than having a 110-basis point lower dividend yield) and has similar if not superior growth potential ahead of it, it is also important to note that IBM’s credit rating is meaningfully superior, and its business model generates more predictable cash flows than AVGO’s does.

Investor Takeaway

For being major tech players in key tech segments that will help shape the future of the global economy, both IBM and AVGO offer surprisingly high dividends yields, and AVGO’s total shareholder capital return (i.e., dividends plus buybacks) is particularly attractive. Both businesses boast ~9% free cash flow yields, alongside solid growth potential for years to come. This makes them attractive plays for income investors looking for some technology exposure.

However, we prefer AVGO at present due to the fact that it has a much better track record, it is cheaper on a historical and head-to-head basis, is returning more capital to shareholders, and we have more confidence in the durability of its competitive advantages.

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