It’s a pretty well-documented fact that one of the best-performing sectors in the entire market for the last few years has been the Technology sector. Tech stocks have been a prime focus of attention for investors for more than two decades, and even with the early 2020 bear market drop, it is companies in this sector that provided the means for big segments of corporate America to pivot their operations quickly and keep things running even while sending their entire workforce to work remotely amid broad-based shelter-in-place orders.
One of the interesting things about the tech sector is the way that new, innovative names have a way of capturing investor’s attention for relatively short periods of time. That’s why stocks like Zoom Video Communications (ZM), ServiceNow (NOW), Slack (WORK) and others have gotten most of the buzz over the last year. I’m not marginalizing these companies; in many ways the products and services they specialize in look to be the start of what I think could be a permanent shift in the way daily business is done. That said, while many of these companies are using technology to provide innovative, enterprise-level and cloud-based solutions, they aren’t necessarily reinventing the wheel. Video conferencing and remote, web-enabled meetings are a good example, as there were a number of companies already operating in this space before ZM came along. In just about every part of the sector where you can find a sexy, new name, you’ll find some older, more familiar names that were already plowing that particular field in their own way.
Big Blue itself is a good example of what I mean. International Business Machines (IBM) operates in many of the same business areas as a lot of sexier names, but doesn’t generate the same kind of buzz or excitement. I think that’s partly a function of the fact they’ve been around for so long, and partly due to the challenges that large, established companies in any sector face to keep their business from getting stale. IBM hasn’t been the type of company to rest on its laurels, but it does mean that sometimes pushing new, innovative products and services into service takes longer for bigger companies who are also managing existing, productive revenue streams than for smaller, more specialized companies with a more narrow focus.
In the case of IBM, a good example is the 2019 acquisition of Red Hat, one of the leading open-source software developers that gave IBM a stronger foothold in the data center and cloud computing businesses. The company’s reports indicate that the push into these segments – also called “hybrid cloud environments” – have been scaling successfully into IBM’s various business lines, but the progress gained has taken longer than analyst and even management had forecasted. Don’t think this is all IBM is about, however or even that the rest of their businesses are suffering; estimates indicate that IBM’s IT services manage roughly 90% of credit card transactions and half of the world’s wireless connections. That’s the advantage of being a 600-lb gorilla, and all together it is a reason that IBM fundamentals have survived broad revenue declines that extend back into 2019 and that have managed to improve other critical fundamental metrics like Free Cash Flow. The absence of “sexy,” however is one of the reasons that IBM’s stock has mostly been running sideways for the majority of the past year while the rest of the Tech sector has surged to fresh all-time highs. What does that means for Big Blue’s value proposition? Let’s find out.
Fundamental and Value Profile
International Business Machines Corporation (IBM) is a technology company. The Company operates through five segments: Cloud & Cognitive Software, Global Business Services, Global Technology Services, Systems and Global Financing. The Cloud & Cognitive Software Solutions segment delivers integrated and secure cloud, data and artificial intelligence (AI) solutions to its clients. It comprises three business areas: cognitive applications, cloud & data platforms, and transaction processing platforms. Global Business Services segment provides consulting, business process and application management services. Its Global Technology Services segment provides information technology (IT) infrastructure and platform services. The Systems segment provides infrastructure platforms to help meet the requirements of multi-cloud and enterprise AI workloads. Its Global Financing segment is engaged in financing, which is primarily conducted through IBM Credit LLC, and remanufacturing and remarketing. IBM’s current market cap is about $108.1 billion.
Earnings and Sales Growth: Over the last twelve months, earnings declined -56% while sales were about -6.5% lower. In the last quarter, earnings dropped almost -20%, while sales were almost 16% higher. IBM operates with a narrow operating profile relative to other stocks in the Tech sector; over the last twelve months, Net Income was 7.59% of Revenues and narrowed to 6.66% in the last quarter. The decline is reflective of the effect of declines in IT infrastructure spending, as the pandemic prompted many businesses to pause spending on enterprise solutions.
Free Cash Flow: IBM’s free cash flow is healthy; in the last quarter, it came in at $15.1 billion, which is an improvement from $13.5 billion of the quarter prior, and above the $12.6 billion at the beginning of 2020. That translates to a Free Cash Flow Yield of about 13.89%. The percentage is attractive, but the size of the actual number is a reflection of the company’s operating strength, which should serve it well even if broad economic uncertainty and concern about its data center business continues.
Debt to Equity: IBM has a debt/equity ratio of 2.62. This is a high number and puts IBM among the Tech sector’s most highly leveraged companies. The company’s balance sheet indicates that operating profits are adequate to service their debt, with a little under $14.3 billion in cash and liquid assets (up from $12 billion in January 2020) versus $54.3 billion in long-term debt.
Dividend: IBM pays an annual dividend of $6.52 per share, which translates to a yield of 5.32% at the stock’s current price. IBM is one of the highest dividend payers among tech companies, which is attractive from the standpoint of thinking about using the stock to help generate passive income.
Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but I like to work with a combination of Price/Book and Price/Cash Flow analysis. Together, these measurements provide a long-term, fair value target around $140 per share. That means that IBM is moderately undervalued, by about 15% right now.
Technical Profile
Here’s a look at the stock’s latest technical chart.
Current Price Action/Trends and Pivots: The chart above displays the last year of price activity for IBM. The red diagonal line traces the stock’s drop to a bear market low in March 2020at around $90.50; it also provides the baseline for the Fibonacci retracement line on the right side of the chart. The stock rebounded with the rest of the Tech sector to a peak at around $135 in June before starting to consolidate in a range between $132 at resistance and $117 at support. October saw the stock drop below that range, to a new pivot low at around $106 before surging again to a a peak at around $133 just before the latest earnings announcement; that prompted the stock to drop to around $117, inline with the 38.2% retracement line before rallying in the last couple of days to its current level around $120. Current support is back at $117; a drop below that point could see downside to about $111.50 based on pivot activity in April and May of 2020, with additional downside to $106 if bearish momentum accelerates. Immediate resistance is right around $124, where the stock hovered throughout December, and about where the 50% retracement sits. A break above that level should see short-term upside to about $132, inline with the 61.8% retracement line.
Near-term Keys: IBM is an interesting company, with growing Free Cash Flow, and increasing liquidity from available cash. Their multiyear pattern of declining revenue is a concern, and so is their narrowing Net Income profile. Altogether, I hesitate to call IBM a good value right now. That could change if Revenues start to show consistent patterns of improvement on a quarterly basis, and Net Income begins to strengthen in the months ahead. For now, the best probabilities for success in working with this stock lie in short-term trading strategies. A push above $124 would be a good signal to think about buying the stock or working with call options, with a near-term target price at around $132, while a drop below $117 should be taken as a strong signal to consider shorting the stock or buying put options, with an eye on $111 as a near-term target and $106 if bearish momentum increases.