ModernGraham Annual Valuation Of International Business Machines
Summary
- IBM is not suitable for Defensive Investors or Enterprising Investors following the ModernGraham approach.
- According to the ModernGraham valuation model, the company is undervalued at the present time.
- The market is implying 1.3% earnings growth over the next 7-10 years, considerably lower than the rate the company has seen in recent years.
Following its recent earnings release in which International Business Machines (NYSE:IBM) fell well below the consensus estimate, the market put significant downward pressure on the price. However, it is important not to base an opinion on a company on a single earnings report. It's far too easy to allow emotions into the equation when a company fails to meet a forecast. Instead, Benjamin Graham, the father of value investing, taught that the most important aspect to consider is whether the company is trading at a discount relative to its intrinsic value. It is through a thorough fundamental analysis that the investor is able to make a determination about a potential investment's merits. Here is a look at how International Business Machines fares in the ModernGraham valuation model.
The model is inspired by the teachings of Benjamin Graham, and considers numerous metrics intended to help the investor reduce risk levels. The first part of the analysis is to determine whether the company is suitable for the very conservative Defensive Investor or the less conservative Enterprising Investor, who is willing to spend a greater amount of time conducting further research.
In addition, Graham strongly suggested that investors avoid speculation, in order to remove the subjective elements of emotion. This is best achieved by utilizing a systematic approach to analysis that will provide investors with a sense of how a specific company compares to another company. By using the ModernGraham method, one can review a company's historical accomplishments and determine an intrinsic value that can be compared across industries.
IBM data by YCharts
Defensive Investor - Must pass at least 6 of the following 7 tests: Score = 5/7
- Adequate Size of Enterprise - Market capitalization of at least $2 billion - PASS
- Sufficiently Strong Financial Condition - Current ratio greater than 2 - FAIL
- Earnings Stability - Positive earnings per share for at least 10 straight years - PASS
- Dividend Record - Has paid a dividend for at least 10 straight years - PASS
- Earnings Growth - Earnings per share has increased by at least 1/3rd over the last 10 years using 3-year averages at the beginning and end of the period - PASS
- Moderate PEmg (price over normalized earnings) ratio - PEmg is less than 20 - PASS
- Moderate Price to Assets - PB ratio is less than 2.5 or PB x PEmg is less than 50 - FAIL
Enterprising Investor - Must pass at least 4 of the following 5 tests or be suitable for a defensive investor: Score = 3/5
- Sufficiently Strong Financial Condition, Part 1 - Current ratio greater than 1.5 - FAIL
- Sufficiently Strong Financial Condition, Part 2 - Debt-to-Net Current Assets ratio less than 1.1 - FAIL
- Earnings Stability - Positive earnings per share for at least 5 years - PASS
- Dividend Record - Currently pays a dividend - PASS
- Earnings growth - EPSmg greater than 5 years ago - PASS
Valuation Summary
Key Data
| Recent Price | $163.65 |
| MG Value | $357.65 |
| MG Opinion | Undervalued |
| Value Based on 3% Growth | $213.69 |
| Value Based on 0% Growth | $125.27 |
| Market Implied Growth Rate | 1.30% |
| Net Current Asset Value (NCAV) | -$57.62 |
| PEmg | 11.10 |
| Current Ratio | 1.11 |
| PB Ratio | 11.45 |
Balance Sheet - September 2014
| Current Assets | $47,164,000,000 |
| Current Liabilities | $42,306,000,000 |
| Total Debt | $32,821,000,000 |
| Total Assets | $118,911,000,000 |
| Intangible Assets | $34,418,000,000 |
| Total Liabilities | $104,656,000,000 |
| Outstanding Shares | 997,700,000 |
Earnings Per Share
| 2014 (estimate) | $16.11 |
| 2013 | $14.94 |
| 2012 | $14.37 |
| 2011 | $13.06 |
| 2010 | $11.52 |
| 2009 | $10.01 |
| 2008 | $8.93 |
| 2007 | $7.18 |
| 2006 | $6.11 |
| 2005 | $4.87 |
| 2004 | $4.93 |
Earnings Per Share - ModernGraham
| 2014 (estimate) | $14.74 |
| 2013 | $13.63 |
| 2012 | $12.51 |
| 2011 | $11.10 |
| 2010 | $9.66 |
| 2009 | $8.29 |
Dividend History
IBM Dividend data by YCharts
Conclusion:
After reviewing the data, it is clear that conservative value investors may wish to seek other opportunities. The Defensive Investor is concerned with the low current ratio in combination with the high PB ratio, while the Enterprising Investor has concerns with the high level of debt relative to the net current assets. As a result, both investor types would find the company to be too risky to proceed. That said, any investors willing to speculate about the future of the company may go ahead with the next step of the analysis, which is a determination of the company's intrinsic value.
When calculating an estimate of intrinsic value, it is important to consider the historical earnings results, along with the market's implied estimate for future growth. Here, the company has grown its EPSmg (normalized earnings) from $9.66 in 2010 to an estimated $14.74 for 2014. This level of demonstrated growth is very strong, and significantly higher than the market's implied estimate of only 1.3%. Based on the demonstrated growth, and lessened by a margin of safety, the ModernGraham valuation model estimates a more conservative growth over the next 7-10 years to be around 7.9%. The company would have to see a significant slowdown in growth in order to be worth the current price. As a result, International Business Machines appears to be significantly undervalued at the present time.
Be sure to check out previous ModernGraham valuations of International Business Machines to gain a better perspective!
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