IBM: A Safe Tech Play With 13% Upside This Year

 |  About: International Business Machines Corporation (IBM)
by: Matthew Frankel

Computer services giant International Business Machines (NYSE:IBM) has done very well for its shareholders in recent years, rising almost linearly since the 2008 low of $69.50 (congrats to whoever bought then!). With an outstanding record of creating shareholder value, does IBM still have room to grow? I believe it does.

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Founded in 1911, IBM is a leader in all three categories of the IT market: hardware, software, and computer services. IBM takes pride in its ability to innovate, and spends an awful lot of money on research and development for such an established company, with a budget of $6.3 billion last year. The company was awarded more new patents than any other (6,180) for the 19th straight year, quite an accomplishment when you consider who some of its competitors are.

Originally a hardware manufacturer, IBM has evolved into a leader in computer services and software. 56% of IBM's revenue comes from its services business, 23% from software, and 18% from hardware sales. The company's service business operates in two segments: Global Technology and Global Business Services, which provide strategic outsourcing, integrated technology services, and maintenance. Most of the company's growth is expected to come from its software segment, as well as its expansion into emerging markets.

One of my favorite things about IBM is the great efforts it makes to increase shareholder value. The company has an aggressive share buyback program, repurchasing $15 billion worth of shares in 2011 alone. Over the past five years, the number of outstanding shares has fallen by 17%, an extremely impressive number.

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As if this outstanding buyback plan wasn't enough, the company also has a fantastic dividend history. The company currently pays a 1.75% yield ($3.40 per share), which isn't quite enough to call this an income stock, but a nice stream of cash while watching share price climb is nice. The company also has a fantastic history of increasing the dividend, having done so every single year since 1995, and by an average of 16.63% per year since 2000. Anyone would have to agree; that is a pretty nice yearly raise!

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Yet another reason I love IBM is for its incredibly attractive valuation. IBM currently trades at 12.8 times 2012 earnings, an absolute bargain considering the growth expected for the company. Consensus estimates call for earnings of $16.66 and $18.42 in 2013 and 2014, respectively. This means that analysts expect IBM to grow at a 3-year average annual rate of over 11%, which more than justifies its low valuation. The current P/E ratio is actually very close to IBM's historic average of around 13 times earnings, which gives me a 1-year target price of $216.58, assuming the same multiple.

For those who have read my articles before, I like to look for companies to trade using long-term options where I can create a very favorable risk-reward. Here, I'd like to play this relatively conservative with a call spread using the January 2014 options. I'm a buyer of the already in the money $185 calls for $17.50 and a seller of the $205 calls for $7.60, for a net cost of $9.90. I love this trade because its breakeven point is $194.90, which is just above the current share price. Also, the maximum profit amount of $10.10 (which is even more than the trade costs) is achieved if IBM is over $205 in one year, which is far less than my target price. In other words, even if the stock "underperforms" my expectations slightly, I'll still cash in.

To sum it up, although I love using options, no matter how you invest in IBM, it's hard to go wrong, as long as you're on the long side of the trade.

Disclosure: I am long IBM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.