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Summary

  • After the retreat in its stock price, it is now an excellent opportunity for a long-term investment in IBM at a cheap price.
  • IBM will benefit from its actions to transform parts of the business and to shift aggressively to its strategic growth areas including cloud, big data analytics, social, mobile and security.
  • IBM’s stock is ranked third among all S&P 500 tech stocks yielding more than 2%, according to the "All-Stars: Buffett" powerful ranking system.

IBM (NYSE:IBM) is aggressively transforming parts of its business to strategic growth areas including cloud, big data analytics, social, mobile and security. The company has already invested more than $7 billion to build cloud capabilities, and 80% of Fortune 500 companies use IBM's cloud capabilities, according to the company. IBM also is the undisputed worldwide market leader in fast growing flash storage solid state arrays.

In my opinion, after the retreat in its stock price, IBM's stock is reasonably cheap. IBM's stock has significantly underperformed the market in the last years. Since the beginning of the year, IBM's stock has declined 3.6%, while the S&P 500 index has increased 5.5%, and the Nasdaq Composite Index has risen 4.2%. Moreover, since the start of 2013, IBM's stock has declined 5.6%, while the S&P 500 index has increased 36.78%, and the Nasdaq Composite Index has risen 44.1%.

IBM has compelling valuation metrics and good earnings growth prospects. The company is generating strong cash flows, and it returns value to its shareholders by stock buybacks and by increasing dividend payments. All these factors make IBM's stock a promising long-term investment.

Valuation Metrics

The table below presents the valuation metrics of IBM - the data were taken from Yahoo Finance and finviz.com.

IBM's valuation metrics are very good. The enterprise value-to-EBITDA ratio is very low at 8.67. According to Yahoo Finance, IBM's next financial year forward P/E is very low at 9.20, and the average annual earnings growth estimates for the next five years is at 8.68%. These give a low PEG ratio of 1.06. The PEG Ratio - price/earnings to growth ratio is a widely used indicator of a stock's potential value. It is favored by many investors over the P/E ratio because it also accounts for growth. A lower PEG means that the stock is more undervalued.

Latest Quarterly Results

On April 16, IBM reported its first-quarter 2014 financial results. The Company reported revenue that missed analysts' expectations, and EPS that was in line with consensus. IBM announced first quarter 2014 diluted earnings of $2.29 per share, a year-to-year decrease of 15 percent. Operating (non-GAAP) diluted earnings were $2.54 per share, compared with operating diluted earnings of $3.00 per share in the first quarter of 2013, a decrease of 15 percent. Total revenues for the first quarter of 2014 of $22.5 billion were down 4 percent from the first quarter of 2013.

Although IBM reported revenue that missed analysts' expectations, partly because of actions as it shifts toward a higher valued-added mix, the company raised its full-year EPS outlook. IBM expects full-year 2014 GAAP diluted earnings per share of at least $17.00, and operating (non-GAAP) diluted earnings per share of at least $18.00. During 1Q14, IBM launched its $1.2 billion investment globally to expand its cloud hubs.

Dividend and Share Repurchase

IBM has been paying dividends since 1962, the forward annual dividend yield is at 2.42% and the payout ratio is only 26%. The annual rate of dividend growth over the past three years was high at 14.0%, over the past five years was also high at 14.3%, and over the past 10 years was very high at 19.4%. I consider that besides dividend yield, the consistency and the rate of raising dividend payments are the most crucial factors for dividend-seeking investors, and IBM's performance has been impressive in this respect.

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Source: Charles Schwab

Since IBM is generating strong cash flow and the payout ratio is very low, I believe the company is well-positioned to achieve steady dividend growth going forward.

IBM ended first quarter 2014 with $9.7 billion of cash on hand and generated free cash flow of $0.6 billion. The company returned $9.2 billion to shareholders through $1.0 billion in dividends and $8.2 billion of gross share repurchases. The balance sheet remains strong, and the company is well positioned to support the business over the long term.

Competitors

A comparison of key fundamental data between IBM and its main competitors is shown in the table below.

IBM has the lowest PEG ratio among the stocks in the group. However, it has by far the highest debt to equity ratio.

IBM's Margins and Return on Capital parameters have been much better than its industry median, its sector median and the S&P 500 median as shown in the tables below.

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Source: Portfolio123

Ranking

According to Portfolio123's "All-Stars: Buffett" powerful ranking system IBM's stock is ranked third among all S&P 500 tech stocks that pay a dividend with more than 2% yield - only Apple Inc. (NASDAQ:AAPL) and Cisco Systems, Inc. (NASDAQ:CSCO) have a better ranking. The "All-Stars: Buffett" ranking system is based on investing principles of the well-known investor Warren Buffett. The ranking system is quite complex, and it is taking into account many factors like book value growth, operational P/E, price to book value, trailing P/E, price to tangible book value, price to cash flow and EPS stability. Back-testing over 15 years has proved that this ranking system is very useful.

Technical Analysis

The charts below give some technical analysis information.

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Chart: finviz.com

The IBM stock price is 0.96% below its 20-day simple moving average, 3.08% below its 50-day simple moving average and 0.56% below its 200-day simple moving average. That indicates a short-term, mid-term and a long-term downtrend.

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Chart: TradeStation Group, Inc.

The weekly MACD histogram, a particularly valuable indicator by technicians, is negative at -0.82 and descending, which is a bearish signal (a rising MACD histogram and crossing the zero line from below is considered an extremely bullish signal). The RSI oscillator is at 44.46 which do not indicate oversold or overbought conditions.

Analyst Opinion

Analyst opinion is divided among the 24 analysts covering the stock - two rate it as a strong buy, two rate it as a buy, 18 analysts rate it as a hold, and two analysts rate it as an underperform.

TipRanks is a website that ranks experts (analysts and bloggers) according to their performance. According to TipRanks, among the analysts covering IBM stock there are 12 analysts who have the four- or five-star rating, three of them recommend the stock, and eight analysts have a hold rating on the stock.

Major Developments

According to IBM, it continued to take actions to transform parts of the business and to shift aggressively to its strategic growth areas including cloud, big data analytics, social, mobile and security. On June 16, IBM announced that according to a new research report from Gartner, IBM is the worldwide market leader in flash storage solid state arrays (SSAs) based on revenue for 2013. More customers around the globe are turning to IBM and its flash storage systems than any other company for faster access to insights from Big Data. In its report published June 10, 2014, Gartner identified IBM as the leader with 25 percent of the Solid State Array (SSA) market share revenue. Violin Memory, Inc. (NYSE:VMEM) and EMC Corporation (NYSE:EMC) were ranked first and second, respectively, in 2012.

In my opinion, IBM will benefit from its leading position in the fast growing flash storage market. Many businesses are turning to flash storage as a key accelerator to improve the performance of applications as well as analytics in the era of Big Data.

According to IBM, it has built the world's most complete cloud portfolio, delivering its clients' technology and business processes as digital services. IBM has already invested more than $7 billion to build cloud capabilities, and according to the company, 80% of Fortune 500 companies use IBM's cloud capabilities. IBM is expecting to benefit from its move to focus on cloud and big data analytics. Since these activities are fast growing, I believe that there is a good chance that this strategy will position the company to achieve long-term growth.

Conclusion

IBM will benefit from its actions to transform parts of the business and to shift aggressively to its strategic growth areas including cloud, big data analytics, social, mobile and security. IBM has compelling valuation metrics and good earnings growth prospects. Furthermore, the company is ranked third among all S&P 500 tech stocks yielding more than 2% according to "All-Stars: Buffett" powerful ranking system. IBM is generating strong cash flows, and it returns value to its shareholders by stock buybacks and by increasing dividend payments. All these factors bring me to the conclusion that IBM stock is a smart long-term investment. Furthermore, the rich growing dividend represents gratifying income.

Source: Why IBM's Stock Is A Long-Term Investment Opportunity