Why IBM's Success Will Continue

| About: International Business (IBM)
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For decades, International Business Machines (NYSE:IBM) has been praised as a technology bellwether and a superb innovator. Recently, however, the stock has lagged the broader averages, rising only 5-6% over the past year while the S&P gained 24% during the same period. This underperformance may be an opportunity to gain exposure to this tested industry leader, and more broadly, the technology sector as a whole. IBM has a long history of strong performance through good times and bad, and this dominance doesn't look to be ending any time soon.

IBM is an information technology, or IT, company that generates income by helping its clients solve business challenges and become more efficient. They use their hardware, software, and financing to help clients cut costs and generate revenue. IBM is a dominant innovator, with nearly 67,000 patents secured since 1993. In fact, Big Blue has been the top recipient of patents for 20 consecutive years, and in 2012 it received 6,478 new patents. This outpaced the combined patents for Accenture (NYSE:ACN), Amazon (NASDAQ:AMZN), Apple (NASDAQ:AAPL), EMC (EMC), Hewlett-Packard (NYSE:HPQ), and Intel (NASDAQ:INTC) during the same year. This impressive statistic shows that IBM knows how to create products that continue to generate excitement and, more importantly, a constant revenue stream for the company.

IBM's competent management team has steered the company through a variety of challenging situations and has continued to create shareholder value. Ginni Rometty, the current Chairwoman and CEO, is a veteran of the company, having been with IBM for 32 years. Rometty has been listed on Fortune magazine's "50 Most Powerful Women in Business" for 8 consecutive years, garnering the #1 spot in 2012. Before taking the position of CEO, Rometty held the title of Senior Vice President and Group Executive for Sales, Marketing, and Strategy. This rise through the ranks of IBM shows that Rometty has the experience needed to keep the company on the cutting edge of the IT industry. Having taken the CEO position in January of 2012, however, Rometty needs more time before her true leadership abilities are shown. Until then, her prior record at IBM means that Rometty is ready for her role at the helm of the company.

IBM's strength lies in its flexibility and its ability to constantly adapt to generate superior earnings and revenue. The company's strategy is to move out of the more tepid hardware business and into software and services, which provide higher margins. In 2010, IBM outlined a financial road map to the year 2015, declaring operating EPS to be at least $20 by then. With current earnings at $14.47 per share, this means they think EPS should grow by around 12% per year to meet those targets. This matches what IBM has been able to achieve in the past, as average earnings growth over the past five years have come in at 13-15% a year. So even if growth slows slightly, IBM will be able to meet its earnings projections without major issue. If IBM's current multiple of 14.30 stays relatively even until 2015, $20 EPS would mean roughly a $280-$290 price by 2015, which gives a 39% upside from current levels. This assumes that IBM's multiple doesn't expand, which is very possible given the recovering economic environment and investor sentiment. If growth continues in the United States and around the world, or if IBM's multiple were to match that of the S&P 500 at around 16, investors would see the share price move much higher than could be expected.

IBM aims to improve margins through acquisitions, and continued their strategy by recently announcing their plans to buy SoftLayer, a cloud computing company. Around the time IBM announced the acquisition, Salesforce.com (NYSE:CRM) also announced their plans to acquire ExactTarget (NYSE:ET) for $33.75 a share. With both transactions announced in quick succession, there is a chance IBM's acquisition was overlooked by the Street. As IBM spends more money on shifting to higher margin businesses, the new cash flow will transfer to the bottom line and give earnings the boost they need to impress investors.

One such investor that has backed IBM's strategy is none other than Warren Buffett, who has been increasing his stake since November 2011 when he announced his interest in the company. IBM now makes up more than 17% of Buffett's portfolio, a vote of confidence to management and to the company. Buffett has cited the superb financial management of the company as the reason he started buying, in this case when talking with Forbes about his investment:

…their financial management was equally brilliant, particularly in recent years as the company's financial flexibility improved. Indeed, I can think of no major company that has had better financial management, a skill that has materially increased the gains enjoyed by IBM shareholders.

Warren Buffett's investment in the future of IBM should be a positive sign to investors for the future of the company.

IBM also seeks to reward shareholders through dividend payments and share repurchase plans. For 100 consecutive years, IBM has paid a dividend to investors, and pledges to steadily raise the dividend to give capital back to shareholders over the long term. The company also pledged in their 2015 road map to spend $50 billion on buybacks to reduce shares outstanding. This combination augments the price appreciation of IBM's stock, and serves as a cushion should unexpected rough times hurt shareholders.

All these factors considered, IBM has proven itself as a veteran of the technology sector, and has positioned itself to continue to succeed for many years to come. With a strong management team and a clear, transparent strategy, IBM should be a company that investors cling to for capital preservation and appreciation over the long haul.

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.