IBM: P-RAGE Ratio Looking Good

Apr.16.14 | About: International Business (IBM)

Summary

IBM's PE Ratio is 13.12 versus Market Cap Weighted PE for the industry of 18.39. This suggests the stock is cheap.

IBM's Forward PE Ratio is 9.96 versus Market Cap Weighted Forward PE for the industry of 15.82. This suggests the stock is cheap.

IBM's PEG Ratio is 1.45 versus Market Cap Weighted PEG Ratio for the industry of 1.63. This suggests the stock is cheap.

IBM has a beta of 0.72, compared with a market beta of 1. The P-RAGE Ratio (PEG Multiplied by Beta), which risk-adjusts the PEG Ratio, is attractive at 1.0432.

Overall, the risk-reward ratio for IBM is very healthy.

I thought I'd have a quick look at International Business Machines (NYSE:IBM), since I like this stock. Everyone knows how to calculate the PE Ratio: simply divide the price by earnings. Thus, for example, if Schlumberger (NYSE:SLB) has a PE Ratio of 19.35, while IBM has a PE Ratio of 13.13, we know that International Business Machines is the cheaper company and the latter wins on value.

In the 1960s, a smart gentleman called Jim Slater realized that there is more to the math of the multiple. He came up with the Price/Earnings Growth Ratio [PEG]. This is a lovely ratio to use, because it brings the growth differential in as an investment consideration. It is simply the PE Ratio divided by the long-term growth rate expectation. Thus, if Schlumberger has a five-year growth rate expectation of 18.65% and International Business Machines has a five-year growth rate expectation of 9.06%, Schlumberger has a PEG Ratio of 1.037 [19.35 divided by 18.65), while International Business Machines has a PEG Ratio of 1.449 [13.13 divided by 9.06]. Since Schlumberger has the lower PEG ratio, it wins on value adjusted for growth.

There is so much more to the math of the multiple that I wrote a post on it, which you can read here. Now this is an awfully convoluted process, and people like simple: and simple works. What is missing in the PEG ratio is risk adjustment. I thought it might be worth multiplying the PEG Ratio by Beta to develop a P-RAGE ratio: that would be Price/Risk-Adjusted Growth & Earnings Ratio. This ratio would simply multiply the PEG ratio by Beta to introduce an element of risk adjustment. Thus, since Schlumberger has a PEG Ratio of 1.037 and a Beta of 1.54, it would have a P-RAGE ratio of 1.596. International Business Machines, with its PEG Ratio of 1.449 and Beta of 0.72, would have a P-RAGE ratio of 1.0432. Since International Business Machines has the lowest P-RAGE ratio, it wins on value adjusted for growth and risk.

In the above paragraphs, I have used Schlumberger merely to illustrate a point.

I like International Business Machines. A couple of years ago, I had written some code to facilitate stock selection. It would help if you read about the build-out of that system here, as that will allow you to appreciate the model output later in this post better.

AOM Statistical Scores

The AOM statistical scores are a statistical evaluation of thirty-eight key indicators for the company, grouped into value, growth, quality, and momentum categories. It illustrates how the key indicators for the stock perform in comparison to the market capitalization weighted scores for the market, the stock's sector and the stock's industry of operation. For International Business Machines, the scores are strong on value, quality and momentum, and weak on growth.

Source: Alpha Omega Mathematica

International Business Machines scores high on value. As you can see from the various value indicators below, it beats the market cap weighted key indicator for its industry of operation in most of the key indicators. I like low PE ratios with lower forward PE ratios, reasonable PEG ratios and a dividend yield which has been growing nicely.

Source: Alpha Omega Mathematica

International Business Machines scores poorly on growth indicators. As you can see from the various growth indicators below, it loses to the market cap weighted key indicator for its industry of operation in most of the key indicators. But forward five-year growth expectations are quite reasonable, at 9.06%.

Source: Alpha Omega Mathematica

International Business Machines scores high on quality. Insider and institutional ownership is low in comparison with industry peers. But the fact that Warren Buffett is a substantial holder goes a long way in making me feel quite joyful about ownership quality. As you can see, the various return and profitability quality measures are vastly superior to industry standards.

Source: Alpha Omega Mathematica

Finally, we get to momentum. International Business Machines has underperformed industry peers for the year and half year. But it has been catching up this past week, month, quarter and year-to-date. It may feel sad to see International Business Machines closer to the 52-week low than market cap weighted industry peers. On the other hand, it is also closest to the 52-week high. Overall, momentum is positive.

Source: Alpha Omega Mathematica

AOM Model Recommendation

The AOM Statistical scores weighted differently for fifteen strategy combinations made up of five stock selection styles and three capital allocation styles to arrive at the AOM model recommendations. International Business Machines is viewed neutrally by persons who have a growth bias in their stock selection strategy, regardless of whether they allocate capital using a sector, industry, or a sector or industry bias-free capital allocation strategy. Value, growth, momentum, balanced and stock selection style-agnostic stock selectors view the company favorably, regardless of whether they allocate capital using a sector, industry, or a sector or industry bias-free capital allocation strategy.

Source: Alpha Omega Mathematica

After analyzing fifteen stock selection and capital allocation strategy combinations, the system assigns an AOM Score of 70% and an AOM Buy Recommendation for IBM.

Source: Alpha Omega Mathematica

The AOM Statistical scores (the first table on this chart) for each of the fifteen strategy combinations are unique, and are not comparable with each other. The AOM Score is very different from AOM Statistical scores: it evaluates and rates the AOM Statistical scores for each of the fifteen strategy combinations, and uses a unique technique to make the statistical scores across the strategy combinations comparable. The output is the AOM Score: a quantitative assessment of the output from the fifteen strategy combinations. The AOM Recommendation is a plain-English recommendation based on the quintile the AOM Score falls in.

I'll hasten to add that this is a package aimed at generating ideas, it does not intend to, nor does it replace, the due diligence we must do as investors. It is a tool which uses quantitative techniques to understand the behavior of different market participants, and then brings that data together so that users can hear the voice of the market through the noise. The AOM system can guide you where to look, but make no mistake about it - it cannot look for you.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.