Continuous evolution and adapting to one’s environment is key to survival. This was first stated by Darwin in the context of life form on Earth. However, the essence of its meaning can very well be applied to businesses and corporations. Great many American corporations that failed to adapt with changing business environment have perished. IBM is one company that seems to understand Darwinism. I believe IBM is a one of success stories of business transformation.

IBM was the company that invented and helped develop many of the electronics and semiconductor industry’s significant technologies. It had been one of the early adopter of the concept of using electronics in actual products for ease of computing. Examples are personal computers, DRAM memories, hard disk drives, and numerous other component hardware technologies. It flourished with those electronic products. However, today’s IBM gets less than 20% of its revenue (which is continuously decreasing) from hardware products.

In early nineties, IBM was confronting a challenge. The challenge was how to transform a global computer behemoth that was a leader in every market it served, but continued to lose market share to its competitors. It did not happen until Louis Gerstner Jr. became the chief executive. Gerstner, in his book “Who Says Elephants Can’t Dance?” mentions that very few people understood how close the firm was in running out of cash.

IBM was facing onslaughts from Intel (with its chips) and Microsoft (with its operating system). In early nineties, IBM recognized its failure to compete and abandoned its OS/2 software product. By late nineties, IBM also slowed its development of personal computers. The company that was at the forefront of developing those products was not longer making money out of it.

Gerstner set new direction and newer priorities by starting IBM Global Services. It shifted its focus towards selling “solutions” rather than just products alone. The new thrust was for on-demand solutions. It concentrated on the higher end of the solutions consulting rather than the lower end outsourcing business. In its “solutions”, it hitched its hardware product like PCs, services, software, and technical services. Along the way, it sold its PC division which had become a commodity. To me it was a very good example of exit strategy for an existing business. Instead of rapid abrupt selling, it slowly transformed and abandoned its star performer of the past.

The on-demand concept (or solution offering) was initiated by Gerstner, while the present chief executive, Sam Palmisano, has taken it to the next level. He has hit the final nail in transforming IBM from hardware company to one led by software and services. IBM focused on the idea that customers want bundled “solutions” of software, hardware and services tailored to specific company and industries rather than a catalog of standard products.

If Louis Gerstner made IBM dance, then Sam Palmisano is making it prance.

Today, many such American companies are at cross roads. At least on the technology sector, HP is making moves to become less dependent on hardware, Cisco is attempting to combine hardware/software/consulting, Google is trying something other than search, Amazon wants to do more than selling books, etc., Time will tell which one will succeed and thrive.

As a dividend investor, this is what I am looking for; a corporation that is willing to adapt, a corporation that does not want to live in its past, but wants to grow continuously by evolving. That’s how a company can sustain growing dividends for longer time. Few other aspects that I like about IBM is that it can be used as proxy investment for international developed markets, emerging markets and technology exposure.

This article originally appeared on The DIV-Net, March 25, 2009.

Standard and Poor’s “S&P North American Technology Sector Index” (henceforth referred as Tech index) is widely used to benchmark the technology sector in North America. As of February 2008 the Tech index had a weightage of approximately 20% to 23% in overall S&P500 index.

The Tech index represents different sub sectors that include hardware (20 companies), internet (21 companies), multimedia networking (27 companies), semiconductors (43 companies), services (31 companies), and software (40 companies). This is a total to 182 companies in the Tech index. However, similar to any market capitalization based index, Tech index is also top heavy. The cumulative weightage for top 10 companies is approximately 64%, for top 20 companies it is approximately 79%, while top 30 companies it is approximately 86%. The table below shows top 30 companies including the annual per share dividends. There are 17 companies out of top 30 companies that pay quarterly dividends.

Technology Dividends

In general, the notable positive characteristics of tech titans are free cash flow, low level of debt (zero in many cases), higher gross margins, and cash on balance sheet. In this first group, the prominent one are that have paid consistent dividends. These include AT&T (T), International Business Machines (IBM), Verizon (VZ), Automatic Data Processing (ADP), and Paychex (PAYX). These companies have demonstrated sustainability of dividends and growth of dividends over a period of time. Keen observer will note that these companies are from services sector. All type of dividend investors know these companies very well.

In addition, the second group consists of notable tech titans that have paid or started paying small amount of dividends in last few years. These are Qualcomm (QCOM), Intel (INTC), Microsoft (MSFT), Hewlett and Packard (HPQ), Texas Instruments (TI), and Master Card (MA).

Contrarily, there are few other companies that have not had any favorable dividend policy. The argument for no dividends has been that they need cash for continued innovation and growth. In this third group, the prominent ones that have not paid dividends are Cisco (CSCO), Apple (AAPL), Google (GOOG), Oracle (ORCL), EMC Corp (EMC), eBay (EBAY), and Dell (DELL). Keen observer will note that majority are these companies are from hardware sector.

First group: These companies have demonstrated favorable dividend policy. If not all, then for most of the companies, pricing have come down to an attractive level.

Second group: These companies are the ones that have potential to become dividend champions (and may be dividend aristocrats). The most promising ones are Intel (INTC), Qualcomm (QCOM), and Master Card (MA).

• Intel: Its technological-driven market leadership is so high that it just does not have any significant competitor. It still continues its hunger for more product diversification such as netbooks, WIMAX, etc.
• Qualcomm: Its CDMA technology provides a stable royalty based cash flow, its chipset in CDMA and 3G domain is market leaders, attempting to diversify in netbooks with new platforms, and chipset competitors (Freescale, Infineon, TI, et. al.) falling apart. It would be prudent to say QCOM is soon becoming Google of wireless communication.
• Master Card: Its service based business model and world wide reach makes it a potential dividend investment.
• Microsoft: I did not include it because I am wary of its habit of squandering cash in meaningless acquisitions.

Third group: At the time of this writing, Oracle declared its first dividend. In addition, one other company to watch out for start of dividends is Cisco. It’s chief executive has shown some inclination to start paying dividends. Apple and Google have not shown any inclination to pay dividends. Dividend investors will have to wait and watch until companies in this group have shown some consistency and sustainability.

The first group and second group are where dividend opportunities exist for long term dividend investors.

Full Disclosure: At the time of this writing, long on INTC and PAYX.

A quick and simple answer is, no it does not affect dividend growth if dividend investors understand what it really means.

Corporations pay dividends from the combination of profitability, cash flow, income, prudent money management, etc. With the current state of economy in United States (and other parts of the world) majority of the corporations are facing negative growth. In such a scenario where will dividend growth come from? In these challenging environment dividend investors need to look at the macro economic scenario and understand how it will play out in long haul over a period of next 10 years, 20 years, or 30 years.

We read a lot about demise of US dollar. At a very fundamental level, which country’s currency becomes a global currency will depend upon political maturity and economic stronghold at global level.

• United States: Every nation in this world wants to do business with US because of its strength in free market system, strength of its institutions, innovative and entrepreneurial business environment, and open minded consumer base. History shows us that every bust is followed by a boom albeit of a different economic form or shape or pattern. Looking back 100 year or more we can see boom and bust in different sectors such as first in textile industry, then infrastructure industry, then automobile industry, then space and airline industry, then hardware and software industry, and finally real estate and financial industry. The present financial crisis may shrink US GPD by couple of trillion dollars from 13 trillion, but still it will be the largest economy.

There is definitely some rational logic behind demise of dollar and I would agree to most of them. However, there is fundamental flaw in this chain of reasoning. While there is lot of talk of demise of dollar, it does not talk about its replacement? Which currency in the world will replace US dollar? There is also a lot of discussion that emerging markets (particularly BRIC nations) will be the driver of global economy. In order for BRIC nations to provide leadership at global stage, these nations have to demonstrate political maturity and economic foresight to the global citizens.

• China: It has a long way to go in demonstrating trust among in own people first and then among League of Nations. History suggests that world domination comes only after prosperity of its own citizens. A nation cannot dominate beyond its borders with struggling and constraint population. It’s currency, Yuan, has trust issues among the global nations. Who wants to trade in Yuan?
  
• Brazil: It is still just a potential and needs to show political maturity and independent thought at world stage.
• India: It is too diverse, too much democratized, and busy with inconsequential bickering with neighbors. It’s economy is growing but still not in top five to have any meaningful bargaining power. It’s currency, Indian Rupee, is still searching an identity and role at world stage.
• Russia: It may perhaps have some legacy military strength; however, it is still confused between communism and free market economy. Its currency, Rubble, is no way near to be global currency.
• Japan’s stagnant economy and aging demographics is not able to support the cause of Yen being global currency.
• The nearest contender is European Euro. Last few years it has thrown challenge to the US Dollar’s status. I believe the issue with Euro is that it represents the bigger economies (e.g. UK, France, Germany, etc) and smaller economies (other European nations). It represents multiple countries. Other than the largely available European market, it does not have any other argument or bargaining strength. Individual countries still continue to use their own currencies and have not shows any inclination to phase it out. I believe it is still in its infancy, in a sense that it still needs to shows its resilience amidst fragmented political landscape.
  

While in long term evolutionary basis, 30 or 40 years down the line, one may see the change, but I don’t expect this to see within next 20 years time frame. I would go only so far as saying that for next 12 to 20 years, BRIC nations will be the catalyst in real global growth and corporate earnings. Here in US we are facing some head winds and perhaps may continue to do so in near future. I cannot predict when this will end.

I can say that in next 10+ years, there will be quite a large number of US and other multinational corporations that will still standing on their own strengths. There are quite a few corporations that are well positioned to continue their growth in developed markets and emerging economies. Mentioned below is the list of companies that are deriving their revenue (and hence earnings) from all types of economies. Figures in bracket indicate approximate percentage revenue from emerging markets. Most of these corporations have paid growing dividends in last five years as measured in their native currency.

• Proctor and Gamble (35%)
• Unilever (30%)
• Johnson and Johnson (60%)
• Qualcomm Inc. (60%)
• Intel Corporation (50%)
• International Business Machines (45%)
• Microsoft Corporation (33%)
• ABB (27%)
• The Coca Cola Company (60%)
• Pepsico Inc. (50%)
• Cadbury PLC (24%)
• Nestle (26%)
• Siemens AG (23%)
• Vodaphone PLC (20%)
• Exxon Mobil Corporation (60%)

Summary is…

I cannot predict what will happen to the value US Dollar and/or future growth from emerging markets. Dividend growth investors have many choices to position themselves which will blunt the effect of these issues. Invest in dividend growth companies that have notable presence in all markets. After that, the discussion of dollar demise becomes purely academic in nature.

Another option is to simply track Dow Index which can done by Dow Diamonds (DIA).

Full Disclosure: Long on PG, UL, PEP, JNJ, and INTC