In a previous article, the concept of Technology Staples was introduced, illustrating how a group of well-known technology companies have been beating the stereotype of being volatile, by offering investors steady returns, even though the roughest economic conditions.
Now let's investigate the original Technology Staple, (IBM).
Incorporated: 1911 (Tabulating Machine Company founded in 1880s)
Cash: $12.3 Billion
IBM has been providing technology solutions for over an entire century. The company behind the PC revolution was once considered left for dead, only to be resurrected as a service providing juggernaut in the 1990s.
Big Blue has been through every major technological change over the past century, and successfully navigated every paradigm shift, from punch cards and typewriters (we all remember what those are right?), mainframe computers, personal computers, laptops, the introduction of the Internet to the masses, and now working with mobile and cloud.
IBM is a one stop shop, where businesses can have their entire technology needs met - from hardware, software, services, and ongoing support. IBM can meet pretty much meet any need a company can think of.
Legendary investor Warren Buffett has been acquiring the company, and declared its wide moat position due to its competitive advantage of having high switching costs for its customers.
One criticism against IBM is a proposed paradigm shift in IT infrastructure, software and services towards the cloud-centric model, which offers a direct threat to the traditional in-house data center model that IBM provides its customers.
Cloud, in theory, provides on-demand switching for customers, with no upfront capital expenditure, and minimizes total cost of ownership of data center equipment and its supporting expenses (power, staffing). This hot technology is very appealing for senior managers, who may have trouble justifying a big capital request, but can easily absorb incremental, smooth subscription costs over the lifetime of a software platform, and also deliver a solution much more quickly to the business.
Hardware Margin Compression
A second criticism against IBM is continuing compression of hardware revenues. For the past decade, technology hardware has become a commodity as economies of scale, and major processor power improvements have reduced costs to customers dramatically.
Positioned for Steady Growth
However, my analysis indicates that IBM, a leader in the industry, has foreseen both trends, and has already positioned itself to meet upcoming threats, and take advantage of the opportunities which the growing Cloud market provides.
While continuing to maintain a leadership position in enterprise hardware, IBM has recognized the margin compression and has shifted its growth strategy towards higher margin software, leveraging its experience with penetrating emerging markets.
Although often viewed as a slow moving company, IBM has a tremendous ability to shift its enormous resources towards emerging technology. After all, it was IBM that invested over $1 billion into Linux in the early 2000s in order to push it into the enterprise.
To meet the threat of cloud providers, such as Amazon (AMZN), the company has its own cloud strategy, offering both hosted solutions, along with private clouds for its customers.
SWOT Analysis Summary
- Strong management with experience, clear vision, realistic goals, and successful execution
- One stop shop which can vertically integrate any customer, for a complete hardware, software, and services solution.
- World class sales force
- History of deep research and development - resulting in five Nobel Prizes and more patents than any US technology company
- Very high understanding of international markets in which it operates
- High switching costs for existing customers
- Cost savings over the past decade, produced by offshoring to less expensive labor sources, has reached diminishing returns status
- Due to size, slower growth rates than other technology peers such as Apple (AAPL), Amazon, or Google (GOOG)
- Share repurchasing while stock selling at a premium
- Building on double-digit growth in emerging markets and business analytics
- Track record of innovation and execution - able to capitalize on any emerging technology to provide business solutions, including mobile and cloud computing
- Shifting growth towards high margin software, analytics, and smart technology to reduce continuing hit from hardware margin compression
- Cloud computing competition offers low cost of entry, compared with the traditional in-house data center model
- Continued margin compression on hardware
Key Income and Value Metrics
IBM scores well in many areas. Looking at the charts, earnings and dividend growth are extremely impressive and reliable. The low PEG shows we can buy growth for a reasonable price.
The low payout ratio, huge cash stockpile and increasing earnings means IBM can sustain its dividend growth with no problem.
However, a concern for my value investing style is the premium over the Graham Number. I prefer my stocks to have a discount to the Graham Number, and unfortunately, IBM is selling at a major premium. This is a well-run company, and the market is clearly willing to pay a premium for this level of quality.
5-year dividend Growth: 21.4%
Payout Ratio: 0.23
P/E - ttm : 14
5-Year PEG: 1.3
Percentage over Graham Number: 152.02%
O-Metrix Score: 5.29
Data: MSN. Chart: Stock Market Functions Add-in for Excel
Data: MSN. Chart: Stock Market Functions Add-in for Excel
Due to its track record of producing steady returns for shareholders, IBM has the honor of being one of the few technology companies actually included in the PowerShares S&P Low Volatility Fund (SPLV).
IBM's low P/E, low PEG, low payout ratio, steadily increasing earnings and very high dividend increases are very appealing.
While I really like IBM as a world-class company, an industry leader, and have full confidence in management, I find it does not meet my value expectations for entering a new position, at current prices.
Another issue I have with the stock is the continuous share buybacks at high prices. I would prefer buybacks to be done at a discount, as Intel (INTC) is currently doing.
When it hits the right price, IBM would be a great Technology Staple for the long term, so I will be keeping it on my watch list, for any major pullbacks.
Disclosure: I am long INTC.