You might think it’s unfair to pit tech services firm Computer Sciences (NYSE:CSC) against behemoth IBM (NYSE:IBM). But both are highly dependent on growth in the information technology consulting industry.
On Tuesday, shares of CSC suffered a nasty spill — falling more than 12% — on anticipation that its latest-quarter earnings would come in below expectations. Does that price plunge make CSC a bargain, or are you better off with Big Blue in your portfolio?
As part of its profit warning, CSC said the U.K.’s National Health Service would slash the size of a large contract and that federal procurement delays would reduce the company’s backlog. This makes me think that CSC is too dependent on a government sector that is likely to be shrinking as countries try to cut their budget deficits.
Meanwhile, IBM is going gangbusters. As I wrote on April 21, IBM beat expectations and raised its guidance after reporting first-quarter earnings on the 19th. Its operating earnings rose 21% to $2.41 a share — beating estimates of $2.30 a share — on revenue that climbed 5% to $24.6 billion.
Not only that, but IBM boosted its EPS estimate for the full year from “at least $13? to “at least $13.15.” The results were strong due to new hardware, up 40%, and a rise in analytics software, up 20%, about which I wrote, that could account for $16 billion in 2015 sales.
While services are still a big portion of IBM’s revenue, the division is growing more slowly and it has weaker profit margins than IBM’s star business — software. IBM’s services business revenue grew 6% to about $15 billion and delivered pretax margin of 12.5%. IBM’s smaller software business grew faster with much higher margins — generating sales of $6.1 billion in revenue, up 6.3% and earning a pretax margin of 28.3%.
But if you’re looking to make an investment decision now, this analysis should only be part of the story. You might also consider using the price-to-earnings-to-growth (PEG) ratio that compares a stock’s market valuation to its forecasted earnings growth. By that measure, if a stock trades at a PEG of 1.0 or lower, it is reasonably priced. Higher than that, and it looks overvalued.
Here are the results of this analysis for CSC and IBM:
- CSC — 1.60. It trades at a P/E of 8 on earnings forecast to grow 5% to $5.47 by 2012
- IBM — 1.46. It trades at a P/E of 14.6 on earnings expected to grow 10% to $14.57 in 2012
At these PEG levels, buying IBM looks like a better play — not so much because the stock is cheap, but because it’s likely to keep executing so well each quarter and thus sustain the 33% growth rate in its stock price over the last year. CSC shares, meanwhile, have tumbled 15%.
Peter Cohan has no financial interest in the securities mentioned.
