International Business Machines Corp. (IBM) Stock: Should You Buy Now?

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IBM stock - International Business Machines Corp. (IBM) Stock: Should You Buy Now?

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International Business Machines Corp. (NYSE:IBM) has been one of the best-performing blue-chip technology holdings for long-term investors over the decades. Despite a sizable investment from none other than Warren Buffett himself, however, IBM stock has had a rough run in recent years. Since peaking around $200/share in early 2013, IBM fell as much as 40%. However, a recent rebound moved shares up from $120 to $160.

IBM stock logo

The company’s transition from being primarily a hardware firm to a software and services operation has not come easily. However, investors have started to buy into IBM’s new direction.

Is there more good news to come for IBM stock, or have we gotten about as high as we’re going to go?

IBM Stock Pros

Cheap Stock: IBM is a classic blue-chip stock selling at an attractive price. Many value investors have been attracted to the firm, with Berkshire Hathaway Inc. (NYSE:BRK.A, NYSE:BRK.B) leading the way. Berkshire holds more than 81 million shares of the firm, worth almost $13 billion, and Buffett says they’ve never sold stock. IBM stock is attractive for several reasons, including a price-to-earnings ratio of 12 (among the cheapest of the big, blue-chip American firms) and a 3.5% dividend yield on a payment that has improved each year for 21 years.

Additionally, IBM is particularly good at converting profits to free cash flow. It has produced at least $10 billion in free cash flow each of the past 13 years; and it managed $14.7 billion over the past year. That gives it plenty of firepower to keep paying large dividends and buying back stock. While the business may appear stagnant, even maintaining its current size and level of profitability would offer investors substantial returns.

Finally, An Earnings Beat! Remarkably, IBM stock had a nine-quarter losing streak, wish shares dropping in the after-hours session after each report. This company made it almost an art to miss guidance, so Monday’s news of an actual beat is most welcome.

Revenues topped expectations by a decent clip and only fell 2.7% compared to the same quarter last year. IBM had been seeing revenues decline at a significantly faster pace in recent years; the trend toward stabilizing revenues should offer a solid boost to IBM stock. The bottom line also was solid, with earnings beating by 6 cents per share.

Watson Health: Deborah DiSanzo, General Manager for Watson Health, said in a recent interview that the market opportunity for Watson is near $200 billion. While Watson won’t transform into an end-to-end, one-stop solution for the healthcare system, by having the deepest and most robust tool for filtering through and making connections across the vast field of medical data, Watson will become increasingly indispensable for many healthcare professionals.

Biotech firms are using Watson to evaluate potential compounds for new uses. Oncology firms can tap Watson’s expertise to consider the potential benefits of various different forms of cancer treatment. Watson’s ability to process hundreds of medical papers and studies on a subject and find potential connections or correlations is of particular power. While Watson has long seemed like a toy or gimmick designed to win Jeopardy or chess matches, it is rapidly transforming into big business.

Next Page – IBM Cons

IBM Stock Cons

Cloud Eroding Business: IBM has suffered a more than four-year streak of continuously declining revenue. While this latest earnings report is a step in the right direction, revenues continue to fall. Revenues peaked at $107 billion in 2011, and are down to just $81 billion today. That’s a nearly 25% drop.

IBM built its business model on building the best hardware for large computing projects. It had relatively little competition and plenty of repeat business and pricing power. The fundamental transformation of computing toward the cloud and away from on-site servers has hit the company hard. Instead of having its turf to itself, it has entered a hornet’s nest of competition against large talented competitors. Efforts such as Watson give the company a sustainable leg up on the competition, but still, IBM has lost a good deal of its moat. To the company’s credit it has been able to keep margins stable, however when revenues drop this sharply, it’s still hard for IBM’s share price to hold up.

Increasing Debt: Despite generating tons of free cash flow, IBM has felt the urge to engage in financial engineering. Unable to grow earnings the normal way, that is, by increasing net income, the company chose to shrink the share count. By aggressively retiring shares, it has been able to keep EPS on a positive trajectory despite the shortcomings on the rest of the income statement. The company has retired fully 45% of its outstanding shares since 2000, dropping the tally from 1.7 billion to around 950 million.

Buying back almost 800 million shares is no easy feat, and given that IBM stock traded as high as $200 in recent years, many of these shares were purchased at prices well above today’s quotation. To achieve this end, IBM has ramped up its long-term debt load from $21 billion in 2010 to more than $40 billion today. Assuming the business stabilizes, buying back those shares was probably a good idea. But if they run into trouble, that $40 billion in debt could come to be quite a burden.

Bad Perception: An out-of-favor stock can make for a good investment. But you need some catalyst for investors to reassess the company. In IBM’s case, the company is viewed as a geriatric out-of-touch firm that hasn’t aged well and has badly handled the last ten years or so of technological evolution. While cloud and other strategic revenues are ramping up, investors are unconvinced that IBM will be able to bring much substantial to the table in the future.

In a world where aggressive firms like Amazon.com, Inc. (NASDAQ:AMZN) price cloud services at single-digit margins and make them increasingly commoditized, it is hard to imagine IBM producing anywhere near the sort of returns it did in the cushy hardware days. IBM needs to show investors that it has a better handle on the future of technology before IBM stock can command a much higher valuation from the market.

Verdict

People who purchased IBM stock earlier this year got a great deal. With the rally in shares, I’m not rushing to buy more IBM today, but it’s still a decent choice for income-orientated investors.

However, a break to new highs above the $200/share mark will be hard to come by until the company can start growing revenue again and convince investors that it is regaining relevance as a tech innovator again.

As of this writing, Ian Bezek was long BRK.B and IBM. You can reach him on Twitter at @irbezek.

Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek.


Article printed from InvestorPlace Media, https://investorplace.com/2016/07/international-business-machines-corp-ibm-stock-3-pros-3-cons/.

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