IBM’s Stock Sprint Approaching a Hill

NYSE:IBMInternational Business Machines (NYSE:IBM) may be the elder statesman of the technology sector, but its successful reinvention through the 1990s continues to pay off for shareholders more than a decade later. The stock has gained 57% since September 2010, and it’s up 10.7% year-to-date, rewarding those who have remained on board as perception — and valuation — have caught up to the positive fundamental realities. But with the stock now changing hands at $207 a share, can new investors still put cash into IBM?

The answer to this question isn’t as clear-cut as it used to be. While IBM still has a lot going for it, there also are reasons for caution.

First, the positive factors. While these tailwinds are no secret to investors, they are the key factors driving the stock and therefore worthy of a quick review. Specifically, IBM offers a compelling combination of growth potential and defensiveness.

On the growth side, IBM is uniquely positioned to capitalize on the explosive growth of both cloud computing and data analytics — two of the most important trends in technology right now. It’s no wonder that CEO Ginni Rometty has set a goal of $20 in EPS for 2015, far above the $14.92 the company is expected to earn in 2012.

At the same time, IBM — which generates the majority of its revenue from long-term contracts — is in a better position to weather economic downturns than most companies in the technology sector. In the bear market period of June 30, 2008, through March 31, 2009, for example, the stock fell a little over 17%, well ahead of the 32.6% loss for the PowerShares QQQ ETF (NASDAQ:QQQ). Furthermore, the stock is supported by ongoing share buybacks and a well-covered 1.5% yield, which is modestly ahead of the 1.3% yield for the Select Sector Technology SPDR (NYSE:XLK).

While these positives help put a floor under the stock price, they’re already well known at this time. And IBM is no longer particularly cheap — its trailing price-to-earnings ratio, at 15.9, is pushing the upper limits of its five-year range, and is at its highest point since late 2007. The forward P/E is a more reasonable 12.9, but on an estimated earnings growth rate of 11%. This puts IBM’s PEG ratio at 1.17, which is 43% above its five-year average. These numbers indicate that there is little room for disappointment when the company delivers its earnings report April 17.

The stock also is trading above its mean price target of $203.90, which puts it in a zone where the potential for appreciation typically becomes more limited. Consider that last week UBS predicted a strong second half for IBM, together with a 13% dividend increase and the announcement of a new share repurchase program. Still, UBS maintained a “neutral” rating and only upped its target to $203 — in line with where the stock was trading at the time.

Finally, it’s worth questioning whether the combination of buybacks and cost-cutting can continue to drive the stock higher when near-term revenue growth isn’t exactly expected to blow the doors off. Analysts see top-line growth coming in at 1.5% this year and 3.3% in 2013, which is important since the stock has loosely tracked its revenue results over time:

From a technical standpoint, the three-year chart shows that IBM is at the top of a longstanding channel. While this doesn’t guarantee price weakness — as Apple (NASDAQ:AAPL) has taught us with its breakout during the past three months — it does indicate that IBM might have more trouble making headway now than it has of late.

The verdict: IBM still is a great company, and it should hold a prime spot on investors’ buy list if the broader market hits an air pocket in the months ahead. Also, shareholders are unlikely to experience a surprise from negative company-specific news.

At this point, however, the combination of modest top-line growth and an elevated valuation indicate that IBM’s easiest gains are behind it.

As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.

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