3 Pros, 3 Cons for International Business Machines Corp.

The company is still innovating but is IBM stock undervalued or a value trap?

By Lucas Hahn, InvestorPlace Contributor

http://bit.ly/2zIUrki
IBM stock

Source: Shutterstock

International Business Machines Corp. (NYSE:IBM) stock is down 8.52% in a year where the Dow Jones Industrial Average is up 19.2%. This makes it the fourth-worst performing stock in the index.

This blue-chip firm, founded in 1911, helped pioneer modern computing. IBM mainframes dominated during the 1960s and 1970s, but the tech giant stumbled during the transition to minicomputers and then PCs.

Its inventions include the ATM, the hard drive, and magnetic stripe technology. IBM is a leader in artificial intelligence (AI); its Deep Blue computer won a chess game against the world champion in 1996. In 2011, IBM Watson defeated two of the greatest contestants of all time in Jeopardy!  

But while interest in AI has grown over the past few years, IBM stock hasn’t moved much.

 

IBM isn’t a pure-play AI company, but 22.9% of its revenue in the most recent quarter came from its cognitive solutions segment. For these reasons, in an article published in June, I recommended IBM stock instead of NVIDIA Corporation (NASDAQ:NVDA) as a way to bet on AI.

IBM remains a very innovative company, securing a place on the MIT Technology Review’s 50 Smartest Companies list every year since 2010. Still,  IBM is an underperforming stock. Is it a buy?

Pros of IBM Stock 

It holds up better in recessions: We may be in a bull market now, but these don’t last forever. Once the rally ends, most stocks will drop. But some will fall harder than others.

During past bear markets, IBM outperformed other enterprise software stocks. These include SAP SE (ADR) (NYSE:SAP), Microsoft Corporation (NASDAQ:MSFT) and Oracle Corporation (NYSE:ORCL).

IBM held up better in the bear market that began in 2000 and ended in 2002, as well as the one that started in 2007 and ended in 2009.

Maybe IBM stock will hold up better the next time the stock market crashes.

 

Rising Strategic Imperative Revenue: IBM reports revenue in five different segments, but also reports the share of revenue from “strategic imperatives.” These fall into several categories: cloud computing, data analytics, mobile, security and social.

Revenue from strategic imperatives is rising. According to IBM’s 2014 annual report, strategic imperatives accounted for 13% of revenue in 2010. This had more than doubled by 2014, to 27%.

In its most recent 10-Q filing, IBM reported that revenue from strategic imperatives jumped 10% year-over-year, and now make up 45% of revenue.

Valuation: IBM stock isn’t priced to perfection, unlike some of this year’s hottest stocks. The stock is up only 45% over the past 10 years.

IBM trades at 12.67 times earnings and 10.9 times forward earnings. Its enterprise value to free-cash flow multiple is 15.82, and its enterprise value to sales multiple is 2.23.

IBM’s dividend currently yields 3.95%.

Cons of IBM Stock

Stagnant Revenue Growth: Value investors need to avoid buying value traps.

Value traps stocks trade at low valuations not because they’re mispriced by an overly bearish Mr. Market, but because of real concerns with the company’s fundamentals.

Sometimes cheap stocks are cheap for a reason, such as declining sales. IBM recently marked 22 quarters of declining revenue. Sales last year were $80 billion; in 2012 they were over $100 billion.

IBM’s lack of top-line growth suggests that it might be a value trap.

Declining Earnings: Stagnant revenue has led to declining earnings at IBM. IBM’s net income fell 4.45% year-over-year in the most recent quarter, the third quarter of 2017.

IBM’s net income over the trailing 12 months, $11.31 billion, is less than its net income in 2016 ($11.87 billion). In 2015, IBM earned $13.19 billion.

Warren Buffett sold IBM: In an article on General Electric Company (NYSE:GE) stock, published on September 12, I mentioned the fact that Warren Buffett sold all his GE stock. I added that I would feel very uncomfortable buying a stock which Warren Buffett sold.

He pays a lot of attention to the stocks in his portfolio, and if he sells, something might be wrong with the company.

He was right; GE stock is down 23.31% since September 12.

In May, Warren Buffett revealed that he had sold about a third of his IBM stock.

IBM and GE have much in common. They both were founded over a century ago. They are components of the Dow Jones Industrial Average. And in recent years they’ve seen little earnings or sales growth.  

Since Buffett is one of the greatest investors of all time, there’s a good chance he will be proven right again.

Bottom Line on IBM Stock

Contrarian investors avoid buying hot stocks which everyone talks about in favor of stocks with good fundamentals that are being overlooked.

IBM may be falling under the radar; Google Trends suggests that interest in IBM may have waned over the past few years. A reversal of this trend could boost IBM stock.

IBM is still pioneering cutting-edge technologies. It recently made 20 qubit and 50 qubit quantum computers available through the cloud.

And, IBM is also researching the blockchain, the technology behind cryptocurrencies such as Bitcoin. IBM is working with companies such as Wal-Mart Stores Inc (NYSE:WMT) and Unilever plc (ADR) (NYSE:UL) to use blockchain technology to track foods across the supply chain. Such a technology could help prevent the spread of contaminated foods. If these technologies get adopted and receive more media attention, investor interest in IBM will increase, boosting the stock.

IBM’s revenue has declined for years now. Some were encouraged by IBM’s latest quarterly earnings beat. InvestorPlace contributor Tom Taulli thinks the company is on the verge of a “Microsoft-style turnaround”.

Others were more skeptical, attributing the earnings beat to the company’s low effective tax rate.

I think IBM is worth a closer look.

As of writing, Lucas Hahn did not hold a position in any of the aforementioned securities.


Article printed from InvestorPlace Media, https://investorplace.com/2017/11/pros-cons-international-business-machines-corp/.

©2018 InvestorPlace Media, LLC