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International Business Machines Corp. Stock Still Is Way Overvalued

At $155 and 13-times earnings, IBM stock is stuck in no-man's-land

By Luke Lango, InvestorPlace Contributor

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I’m not terribly interested in International Business Machines Corp. (NYSE:IBM) stock here and now. Back in February 2016 at $120 and 9.5x trailing earnings, IBM stock was a great buy. Back in February 2017 at $180 and 14.5x trailing earnings, IBM was a great short.

But at $155 and 12.8x earnings, the stock is somewhat stuck in no-man’s-land here and now.

So when does it become a buy again? I’m waiting for $140. Here’s why.

IBM Is a Low-Growth Company

Recently, IBM stock popped up big after the company reported headline beating third quarter numbers and hinted at positive revenue growth next quarter.

That beat got my attention, but after digging through the numbers, I didn’t find much to like.

A little less than half (45%) of IBM’s business is classified as Strategic Imperatives. This is the part of IBM’s business that’s attractive. It’s growing at around 10%. It has hyper-growth aspects, like cloud (+20%) and security (+49%). It also has stable growth aspects like mobile (+7%) and analytics (+5%).

But when you’re buying IBM stock, you aren’t just buying the Strategic Imperatives side of the business. You are buying the whole business.

What does the other half (55%) of IBM’s business look like? It isn’t pretty. That part of the business is in secular decline, and it will remain so. Granted, as the Strategic Imperatives side of IBM’s business scales, it will start to comprise a bigger piece of the IBM revenue pie and drive positive revenue growth. That is attractive.

But that revenue growth will be meager. Strategic Imperatives revenue growth is already slowing (it was just 10% last quarter). Growth will keep moderating against continued declines elsewhere at IBM. Overall, the Street doesn’t even think IBM can grow revenues over the next several years.

I think they can, but it will look like 0-1% growth. Margins are expected to rebound, but only by a small amount. Overall, then, this a tepid top-line growth story with a tepid margin expansion narrative. Put it all together, and you get an unexciting earnings growth outlook. The Street is looking at under 2% earnings growth per year over the next 2 years.

That seems about right to me.

IBM Is Too Expensive

The question then becomes: what are investors willing to pay for 2% earnings growth?

The answer is not much. Over the past five years, IBM has traded, on average, around 12x earnings. Considering IBM’s low-growth prospects are here to stay, there really isn’t any reason investors are going to start paying more than 12x earnings for IBM stock.

Throw a 12x multiple on the consensus fiscal 2019 earnings estimate of $14.32. You get a $172 stock in two years. Discount that back by 10% per year, and you arrive at a fair value of around $140.

IBM currently trades just under $155.

Bottom Line on IBM Stock

IBM isn’t going anywhere soon. It is a stable company with low-growth prospects.

That means that IBM should feature the same valuation it has over the past five years. Currently, IBM stock is trading at a premium to that 5-year average valuation (12.7x versus 12x). Consequently, I don’t think this stock looks like a good buy here and now.

Historically speaking, IBM becomes a good buy when it trades below 12x, features a dividend yield above 4%, and has a free cash flow yield north of 9% (see February 2016).

Right now, IBM is trading above 12x earnings, features a dividend yield below 4%, and has a free cash flow yield below 9%.

Overall, I am just not too interested in IBM here and now. I don’t like shorting a stock trading at just 13x earnings, but I also don’t like buying a stock trading at a premium to its historical valuation.

Consequently, I’ll watch this stock from the sidelines until it either rises big or drops big.

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


Article printed from InvestorPlace Media, https://investorplace.com/2017/11/ibm-stock-way-overvalued/.

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