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IBM: Is It Cheap Or In Trouble?

The past few years have turned several big tech companies into questionable investments for conservative investors, but International Business Machines (IBM) always remained a worthy component of any grandfatherly portfolio. So it was a little jarring to see IBM slapped with an “underperform” rating in early August by Credit Suisse, who said the company “is effectively in decline.” Has a go-to company far long-term value investors really become a value trap?

IBM Chart

IBM data by YCharts

That’s a particularly pertinent question now. IBM shares are trading at 52-week lows, at relatively low valuations. The historic PE ratio at 13 is its lowest point in about two years. Its forward PE ratio of 10.8 is lower than that of any other big tech company in the Dow Jones Industrial Average except the troubled Hewlett-Packard (HPQ). IBM is cheaper than Microsoft (MSFT), Cisco (CSCO) and Intel (INTC).

IBM Forward PE Ratio Chart

IBM Forward PE Ratio data by YCharts

Yet its dividend grows reliably and remains well backed by cash and earnings, carrying a dividend yield now of slightly more than 2%. Those are particularly coveted features for income seekers in these days of dwindling bond values and interest rate rises.

IBM Cash Dividend Payout Ratio TTM Chart

IBM Cash Dividend Payout Ratio TTM data by YCharts

In other words, IBM has the markings of a quintessential value play. So why the harsh press? The Credit Suisse analysts contend that IBM’s core businesses have lost their competitive edge. Revenues have declined for five straight quarters, and the company missed earnings projections earlier this year for the first time in almost a decade. The investment team sees a decline in IBM’s competitiveness across industries, particularly in its important software division. The team expects very little organic revenue growth for IBM ahead.

IBM Revenue TTM Chart

IBM Revenue TTM data by YCharts

While Credit Suisse is the only major investment team to imply that IBM shareholders should sell, other analysts also see difficulty for the company in achieving long-term growth expectations. IBM has set for itself an EPS of “at least $20” by 2015. (IBM’s reported basic EPS of $14.53 last year and diluted EPS of $14.37.) That goal is made more difficult by current weakness in certain high-margin divisions like software and software integration services.

IBM Operating Margin TTM Chart

IBM Operating Margin TTM data by YCharts

However, most IBM followers see reason for optimism long-term. The services division, a higher margin business, had a 7% rise in backlog last quarter (at constant currency), with gains in both major markets like the U.S. and in growth markets. Industry analysts also note that much of IBM’s recent trouble comes from emerging markets economies. Developing economies like China and Brazil were responsible for 81% of IBM’s revenue growth between 2010 and 2012, and 61% of its profit growth. Most analysts have hold ratings on IBM shares now, in large part because they don’t expect much improvement in these traditional growth markets this year. But those economies will eventually recover and again help IBM’s growth.

IBM has couple of aces on hand that will help it reach its earnings goal even if emerging markets don’t immediately cooperate. First, management there is very good at acquisitions. The company added $1 billion of profit since the beginning of 2010 through 33 acquisitions, and most of the deals exceeded performance expectations. IBM projects some $20 billion in acquisition spending through 2015, with the goal to skew its business mix toward faster-growing markets (products and services.) It likely will sell its growth-dragging, low-end server business by the first quarter of next year. Secondly, the $23 billion left in its current stock buybacks plan should add $1.35 to EPS even without business unit improvements.

Value investing, by its nature, requires patience to endure periods of weakness in return for good performance over the long haul. Long-term investors have done well in IBM for many years – better than investors in the other big tech Dows most of the time. Warren Buffett, one of the best value investors in the world, believes IBM will do well over years to come. His Berkshire Hathaway (BRK.B) has steadily added IBM shares since 2011 to make it the company’s third largest stock holding, comprising nearly 15% of the portfolio. Perhaps that essential decline is really just the opportunity value investors need.

IBM Total Return Price Chart

IBM Total Return Price data by YCharts

Dee Gill, a senior contributing editor at YCharts, is a former foreign correspondent for AP-Dow Jones News in London, where she covered the U.K. equities market and economic indicators. She has written for The New York Times, The Wall Street Journal, The Economist and Time magazine. She can be reached at editor@ycharts.com. Read the RIABiz profile of YCharts. You can also request a demonstration of YCharts Platinum.

Read more articles about: Company Analysis  stocks that look cheap   tech stocks   

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