We recently published a list of Dobermans of the Dow: 10 Stocks to Consider. In this article, we are going to take a look at where International Business Machines Corporation (NYSE:IBM) stands against other Dobermans of the Dow to buy.
The Dobermans of the Dow strategy serves as an alternative to the well-known Dogs of the Dow approach, offering a more selective screening process. While the Dogs of the Dow ranks stocks solely based on dividend yield, the Dobermans method prioritizes high-quality companies trading at attractive valuations. The selection process involves two key steps: first, the 30 stocks in the Dow are ranked by Return on Equity (ROE), with the top 20 retained. Then, these 20 companies are further ranked by Free Cash Flow Yield, narrowing the selection to the final ten stocks, which form the Dobermans portfolio. Historically, a hypothetical portfolio following this approach and rebalanced annually has delivered superior performance compared to the Dow, the broader market, and the Dogs of the Dow strategy, according to a report by Forbes. The report further mentioned that since 2000, this methodology has generated a cumulative return of 810%, more than doubling the long-term performance of these benchmarks.
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The significance of dividend stocks is well established, with extensive research examining their long-term performance. A study by Robert Arnott found that over a period of more than 200 years, ending in 2002, the US stock market delivered an average annualized total return of 7.9%, with dividend reinvestment accounting for 5% of that growth. Beyond enhancing overall returns, dividends also provide a buffer during market downturns. Various studies have shown that companies paying dividends tend to experience lower downside risk and recover losses more quickly, ultimately leading to higher risk-adjusted returns over extended investment periods.
Within dividend investing, companies with a consistent track record of dividend growth tend to attract greater investor interest. A report by S&P Dow Jones Indices highlighted that firms with ample cash reserves are better positioned to sustain and expand their operations while continuing to pay stable or increasing dividends. To assess the sustainability of dividends, companies must evaluate whether their payouts are supported by cash generated from operating activities and the availability of free cash flow. Free cash flow is calculated by subtracting capital expenditures—such as spending on property, plants, and equipment (PP&E)—from cash flow generated through operations. Excess cash can be allocated toward dividends, debt reduction, share buybacks, or business expansion.
A positive or growing free cash flow often signals stable or increasing profitability. Since strong free cash flow may indicate a healthy balance sheet, S&P Dow Jones conducted an analysis to determine whether free cash flow yield—measured as annual free cash flow per share divided by stock price—provides valuable insights into investment returns. The underlying investment thesis suggested that all else being equal, companies with a higher free cash flow yield are preferable, as they generate greater free cash income for each dollar invested.
An analysis of the broader market universe, divided into quintiles based on free cash flow yield, revealed that the top-quintile stocks delivered an annualized return of 15.7% between December 1990 and June 2017. This performance exceeded the returns of all other quintiles and outpaced the broader market by an average of 3.6%. While the bottom two quintiles also achieved respectable returns of 11.0% and 8.6% annually, respectively, both underperformed relative to the overall equity market.
Our Methodology
For this article, we filtered the Dow stocks by Return on Equity, narrowing the list to the top 20. These are then ranked by Free Cash Flow Yield, with the top 10 earning the title “Dobermans of the Dow.” The stocks are ranked according to their free cash flow yield. In cases where multiple stocks had the same free cash flow yield, the number of hedge fund investors was used as a deciding factor. Data on hedge funds was sourced from Insider Monkey’s database, which tracks over 1,000 hedge funds as of Q4 2024.
Why are we interested in the stocks that hedge funds pile into? The reason is simple: our research has shown that we can outperform the market by imitating the top stock picks of the best hedge funds. Our quarterly newsletter’s strategy selects 14 small-cap and large-cap stocks every quarter and has returned 373.4% since May 2014, beating its benchmark by 218 percentage points (see more details here).
A closeup of a woman’s hands typing rapidly on a laptop in a corporate office setting.
International Business Machines Corporation (NYSE:IBM)
Free Cash Flow Yield: 0.05
Number of Hedge Fund Holders: 60
International Business Machines Corporation (NYSE:IBM) is an American multinational tech company that provides a wide range of related services and products to its consumers. Chinese AI firm DeepSeek recently made waves with the launch of a budget-friendly AI model. However, this disruption could work in IBM’s favor. Unlike general-purpose AI, the company’s models are designed for specific applications and come at a relatively low cost. The company’s strategy revolves around helping clients integrate AI to address practical challenges. If DeepSeek’s innovation leads to a broader shift toward more affordable and accessible AI solutions, IBM stands to gain from the trend.
Commonly known as Big Blue, International Business Machines Corporation (NYSE:IBM) has outperformed the market in the past 12 months, surging by nearly 34%, as of the close of March 10. In the fourth quarter of 2024, the company reported revenue of $17.6 billion, reflecting a 1% increase compared to the same quarter last year. The Software segment experienced double-digit growth, fueled by strong demand for Red Hat. Businesses worldwide are increasingly relying on IBM for AI-driven transformation, with its generative AI division generating over $5 billion in revenue—nearly $2 billion more than the previous quarter.
International Business Machines Corporation (NYSE:IBM) demonstrated solid cash performance in 2024, generating $13.4 billion in operating cash flow and $12.7 billion in free cash flow. In the fourth quarter, the company returned $1.5 billion to shareholders through dividend payments. Its quarterly dividend comes in at $1.67 per share and has a dividend yield of 2.60%, as of March 10. It is among the Dobermans of the Dow as the company has been rewarding shareholders with 29 consecutive years of dividend growth.
Overall, IBM ranks 7th on our list of Dobermans of the Dow to buy. While we acknowledge the potential for IBM as an investment, our conviction lies in the belief that some AI stocks hold greater promise for delivering higher returns and doing so within a shorter time frame. If you are looking for an AI stock that is more promising than IBM but that trades at less than 5 times its earnings, check out our report about the cheapest AI stock.
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Disclosure: None. This article is originally published at Insider Monkey.
