Why does Wall Street insist on rewarding companies for being stable and risk averse in almost every sector except tech? There, and only there, cautiousness is perceived as weakness. The phenomenon against a stable tech giant is quite bewildering, akin to the Titanic awaiting an iceberg.
This has been the very case for IBM (IBM), which has been brutally battered to the point of an irrationally low valuation.
The good news is that irrational investors are the makers of bargains on Wall Street.
That, of course, means IBM stock is a bargain that should be picked up before investors turn rational again.
IBM Stock: Why It’s Unjustifiably Low
The key reason why IBM stock has been brutally bruised, shedding around 40% in less than three years, is looming worries over the IT sector. The combination of fierce compaction and stagnant spending suggests that there is a pricing war being waged there.
Those who invested in airlines during the 1990s know that is never good for stocks. Under that lens, investors view IBM’s service as relatively expensive to its peers. They’re afraid that IBM is moving too slowly, and therefore, fear a loss in market share.
That couldn’t be farther from the truth. IBM knows to be patient when it comes to developing new niches and services. When the moment of truth does arrive, i.e. when there is risk, IBM’s patient caution is quickly switched off. Thereafter, a ruthless transformation emerges.
A classic example was the manner in which IBM ditched its PC business some 10 years ago. They sold the hardware division to Lenovo, recognizing imminent danger long before its peers, seamlessly avoiding a collision with the proverbial iceberg.
In fact, its diversion away from the hardware business has been so aggressive that, currently, Morningstar reports that less than 6% of IBM’s revenue comes from hardware.
Rather than being engaged in a pricing war, IBM works hard at seeding greater loyalty from its clients. It does that through the development of new software and provision of unique services, including its artificial intelligence platform Watson analytics. Watson permits on-demand use of its massive knowledge base to developers and service providers. And, of course, there is IBM’s collaboration with Apple (AAPL), which allows the development of uniquely customized apps for corporate use.
Unlike its competitors who seemingly exist on autopilot, IBM works hard to find lucrative segments of the market. It’s well known that the IT sector has been contracting. Despite that, IBM has been able to maintain its market share as the biggest among its peers. That is a clear illustration of a very fruitful strategy.
IBM Stock: Under the Hood
When we delve under the hood it becomes even clearer how much IBM stock is undervalued: It is trading at a price-earnings multiple of 9 — a multiple more suited to a battered oil company.
IBM management has been remarkably disciplined when it comes to cost cutting. They have been able to maintain a net profit margin above 15%, substantially better than competitor Hitachi (ADR) (HTHIY).
While revenues have been somewhat stagnant, that’s related more to the general weakness of the sector than to IBM. Once the cyclical weakness ends, IBM’s revenues will not only grow quickly, but with much better profitability than its peers. And its dividend yield of 3.8% makes IBM stock that much more attractive.
Don’t get me wrong, I’m not inferring that the IT sector’s tough times are about to come to an end. They might, but then again, recovery can take a while. Even under those conditions, IBM stock should at least trade at a multiple appropriate for its strong management and business record. Taking into consideration its size alone, it should be trading at a higher multiple.
So what is that premium? Matching that of IBM’s five-year average of 13 times earnings would be a good start, but it is certainly not the end.
We all know the story of how Apple’s iPhone smashed the cheaper Samsung (SSNLF), both in profits and stock performance. IBM and its cheaper peers share a similar backstory, which means IBM current pain could be the stock’s holy grail.
Eventually, once investors realize how irrational they’ve been, IBM could trade much higher and reward the bargain hunters among us.
As of this writing, Lior Alkalay did not hold a position in any of the aforementioned securities.
