IBM shares are only higher by 4.9% since I said I was comfortable recommending them about a year ago. However, it has been a wild ride and the stock has been significantly higher than it is today this year (11% higher in March). The stock lost value after an earnings disappointment in the first quarter and then fell again with stocks generally on the broad reaching impact of the Federal Reserve's tapering comments in June. IBM has basically been range bound between $180 and $210 since late 2011, and today it is trading right in the middle of that range. The stock also sports a tempered P/E ratio, earnings estimates that appear settled to improving, and a decent dividend yield to boot. As a result, buying IBM makes sense here.
IBM (IBM) reported earnings last week and its shares popped on the news. However, they settled back in by the close of the reporting week. There was enough to be enthused about in IBM's Q2 EPS release, but the news was not all good, keeping the stock tamed I suppose. In my view, the relevance of that reality is that investors have another chance to buy in at value.
IBM reported non-GAAP EPS growth of 8% before workforce rebalancing charges. The company's Q2 EPS of $3.91 far exceeded the analysts' consensus expectation for $3.77. Now those same estimates had been severely reduced over the prior 90 days from a consensus of $3.95, due to the disappointment in Q1, but the result still almost reached the old estimate. It was great news for IBM shareholders who had been on edge since Q1.
Operating profit margins expanded and the company revised its full-year guidance higher, all on the benefit of workforce cuts and the company's constant focus on transition. The company exits poorer performing businesses and focuses on higher growth markets and products and services, which make its shares an investment that is always inherently seeking value preservation and addition.
IBM's revenues fell 3% in Q2, but before currency impact, revenues slipped by a lesser 1%. The top line achievement of $24.9 billion reflects IBM's many businesses and markets of operation. It is notable that its growth market revenues increased by 1% before currency impact. The company's higher value Software revenue was up 5% before currency impact. Also, its high impact and value added segments including Business Analytics, Smarter Planet and Cloud businesses saw marked growth. While its Services revenue fell 1% before currency impact, its Services backlog was up 7% before currency. Value addition was also evident in the company's profit margin expansion. Excluding the workforce rebalancing, the company's gross margin expanded by 1.4 percentage points, to 49.7%.
I led this report with a statement indicating that the news was not all good from IBM, and it was not. Obviously, we want to see the top line number rising, first and foremost. However, there's an expectation that it will get there as new growth markets and products become more important than slowing legacy business. That's not to mention global economic recovery, which I think it is safe to say is expected by most economists today. Cash flow from operations dipped in the quarter as a result of the revenue decline and increased cash use. This would be of concern to me if it were a company specific issue that I thought would continue, but that's not how I feel about it. The company has obviously been impacted by sluggish global economic activity, and is actively working to find value added growth. Finally, among the troubling issues, the company itself said the second half of the year would probably not be as great as it had previously thought it would be.
Still, IBM was able to raise its operating EPS guidance for 2013 to "at least $16.90" excluding the second quarter $1 billion workforce rebalancing charge. That was a significantly greater figure than economists expected, with the consensus EPS estimate at the time set at $16.64 for 2013. Today, that consensus estimate has been raised 1.6% to $16.91.
When I first recommended IBM in July 2012, it was trading at 11.8X my EPS estimate for the forward 12 months. Then, in April of 2013, when I stated that IBM was a standout buy, it was trading at 12.6X the analysts' consensus estimate for 2013. Today, IBM is valued at 11.6X the analysts' consensus for 2013. The stock only costs 11.1X my EPS estimate of $17.645 for the forward 12 months through June 2014. Now, my estimate is not built from an earnings model, but is the average of the analysts' consensus figures for 2013 and 2014. When matched against the growth expectation for the next five years of 10.6%, we get a PEG ratio of 1.05X. That's a modest valuation that seems to ensure at least 10.6% growth in the stock price over the next 12 months. Now, this excludes the 1.9% dividend yield the stock pays today. Considering that it appears to me the Q1 earnings issue is behind this company and that operations could exceed these estimates, I see IBM as an excellent core holding for diversified portfolios and a recommended buy for all on a growth at a reasonable price (GARP) basis.