International Business Machines Corporation (IBM) is an information technology company operating in five business segments. The company's global strategy is to deliver sustained earnings growth by increasing its presence in higher-value business segments such as services, software and integrated solutions, while exiting less profitable business segments.
This strategy is driven by the company's belief that emerging markets will drive 60% of the world's GDP growth over the next four years. My belief is that for that statement to become reality, world demand had better increase in one helluva hurry.
Financial information that may be contained herein, is based on the company's most recent SEC Form 10-K filing for year ending December 31, 2011, as filed with the Securities and Exchange Commission on February 28, 2012.
Management information that may be contained herein, is based on the company's most recent SEC Form DEF 14A filing as filed with the Securities and Exchange Commission on March 12, 2012.
I am not an advocate of short-term investing, as I simply believe the average investor has neither the time, nor the skill, to be successful over a lifetime of investing. With that said, short-term investing information is presented here for those investors that have the time and the money to waste.
My short-term investing information focuses on the 50 day moving average stock price, the 200 day moving average stock price, the 52 week high stock price, and the 52 week low stock price, as compared to a recent closing stock price, all of which change DAILY.
The stock closed recently at $193.49, with first resistance (50 day EMA) at $195.70, a 1.1% increase from the recent close, second resistance (200 day EMA) at $194.10, a 0.3% increase from the recent close, and final resistance (52 week high) at $211.79 a 9.5% increase from the recent close.
On the down side, support is currently at the 52 week low, $177.06, an 8.5% decline from its recent close.
The short-term equilibrium number, the mid-point between resistance and support is $194.90, a 0.7% increase from the recent close. This makes the odds of a successful short-term trade 137 to 1.
Earnings Growth Investing
Earnings growth investing focuses on valuations based on the spread between year over year earnings growth and the current PE.
Because the earnings growth investing strategy focuses strictly on earnings growth, it fails to consider downside risk, leaving individual investors potentially overexposed to market fluctuations.
In the case of International Business Machines Corporation, the company had year over year earnings growth of 17%, ending FY11 with earnings of $16.10 per share versus $13.77 per share in the prior fiscal year.
Based on a recent close of $193.49, the trailing twelve month PE ratio is currently at 12, putting the spread between earnings growth and the PE ratio at 1.53.
This means that for an investor focusing strictly on earnings growth, the stock should be trading at $218.14, 12.6% higher than its recent close.
Any long-term investing strategy should be based on a wide variety of financial metrics, including key performance indicators, raw value estimates, and discounts to those raw value estimates.
Long-term investing strategies should focus on the simple premise that price (value) determines return, meaning that without first determining a value (price), there is no way to predict a return.
In the case of International Business Machines Corporation, my raw value estimate for the stock is in the $63-$77 range, with a buy target of $37.50, a first sell target of $73, and a close target of $77.
Based on a recent close of $193.49, the risk reward ratio for this stock is currently (-2.6).
To most investors, the value of a stock is the price agreed upon between a willing buyer and a willing seller, and certainly that is one sort of value.
But what about the intrinsic or fundamental value, the value of what is left once all of the parts of the underlying business have been examined?
It is this value, this raw value that I am trying to determine when I value a stock.
In support of my raw value estimate, please find a link to my valuation worksheet which may be downloaded from a secure server by clicking here.
Considering the Parts
I break financial statements into categories with each category containing certain metrics on which I like to focus. The main focus categories are Liquidity, Profitability, Debt, Cash Flow, and Dividends.
Additional metrics include Key Performance Indicators, or KPIs, Merger and Acquisition Return periods, and Risk Reward.
The company ended FY11 with a current ratio of 1.21, a quick ratio of 0.98, a cash ratio of 0.28, and a cash conversion cycle of 59 days. The company also ended the year with a book value of $16.59. However, when goodwill and intangibles, which comprise roughly 25.5% of the company's total assets are factored in, the company's tangible book value becomes (-$7.80).
FY11 found the company with a gross margin of 51.4%, an operating margin of 23.1%, a net operation margin after taxes (NOPAT) of 18.3%, a return on invested capital (ROIC) of 34.4%, an effective tax rate of 24.5%, and a cash return on invested capital (CROIC) of 21%.
The company ended FY11 with total debt of $31.3 billion, a year over year increase of 16%. Additionally, the company paid an average annual interest rate 1.31%, a year over year increase of 0.9%, had a debt to cash ratio of 2.6, and a debt to equity ratio of 1.6.
The company's FY11 operating cash flow was $19.40 per share, a year over year increase of 15%. The company also ended FY11 with free cash flow of $12.69 per share, a year over year increase of 18%.
During FY11 the company paid an annual per share dividend of $2.86, a year over year increase of 15.8%. Investors should always be aware that a company is never under any obligation to pay a dividend. Accordingly, there is no guarantee that future dividends will be declared.
Key Performance Indicators
I utilize numerous metrics when analyzing a company's financial information. Of these metrics, there are 17 that form my key performance indicators, or KPIs.
I use these metrics because I believe they best represent the influence management has on the day to day operation of the company.
In my analysis, the higher the KPI number, the better. In the case of International Business Machines, the company has an earned KPI score of 53 out of a possible 99, a year over year increase of 12.5%.
Mergers and Acquisitions
One of the metrics I examine is the relationship between Enterprise Value and EBITDA.
Enterprise value is the company's market capitalization plus all of the company's debt, less all of the company's cash, while EBITDA is simply earnings before interest, taxes, depreciation, and amortization. International Business Machines had a FY11 enterprise value of $209.47 per share, and EBITDA per share of $20.68.
Dividing the enterprise value by EBITDA yields a Merger and Acquisitions number of 10.1, meaning that should the company be acquired, it would take the acquiring entity approximately 10.1 years to recoup their acquisition costs assuming EBITDA stayed constant.
Most acquiring companies want to see their acquisition capital returned over a 7 year or shorter period, meaning that regardless of how accretive to earnings acquiring this company may be, the acquisition investment cycle for International Business Machines is simply too long.
Risk Versus Reward
All risk reward metrics require assumptions, assumptions which can skew results.
I determine my risk reward number by subtracting my close target from the current price and then dividing that number by my buy target multiplied by an assumed acquisition purchase premium of 20%.
In the case of International Business Machines, my risk reward ratio is (-2.6), meaning that at current price levels, the stock price exceeds my raw value estimate by roughly 2.6 times.
In my opinion, there is no value with this stock as a short-term investment, not when the upside potential is a 9.5% increase from the recent close and the downside risk is an 8.5% decline from the recent close.
Factor in my odds of a successful trade at 137 to 1, and a short-term investment just seems extremely ill advised. There also does not seem to me to be much advantage to an earnings growth investment.
Not only is the stock currently trading at about 2.5 times what I believe is its fair value, but it is trading at a level that only leaves the potential for a 12.6% investment return, a return that can be dramatically altered just because.
Again, I believe an earnings growth investment at current price level would be ill advised. Contrary to what many may be thinking, looking at the stock as a long-term investment makes less economic sense than any other investment strategy.
The stock is currently trading at roughly 2.5 times my fair value estimate, it has a negative risk reward ratio, management effectiveness of roughly 53%, a negative tangible book value, not a single investment quality liquidity metric, and $31.3 billion in debt, an amount that grew 16% year over year.
Additional considerations are a spend of $12.40 per share on stock repurchases, a spend of $7.37 per share on long-term debt reduction, and a spend of $2.86 per share on dividends. Why not a spend of $12.40 per share on dividends and $2.86 per share on stock repurchases? Better yet, why not a $7.37 spend on dividends, a $12.40 per share spend on debt reduction, and a $2.86 spend on stock repurchases?
In the end, poor management effectiveness, poor financial metrics, and an extremely overpriced stock lead me to rate this stock a sell.