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 in the middle of a pandemic-driven economic slowdown.
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 have marked the beginning of what many economists are predicting is 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 the market is a different kind of challenge for bigger companies, who are simultaneously managing existing, productive revenue streams. Smaller, more specialized companies with a more narrow focus, on the other hand are able to direct all of their collective, creative and productive energies into innovative products, services, and solutions.
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 industry analysts 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 maintain other critical fundamental metrics like Free Cash Flow at very healthy levels. The absence of “sexy,” however is one of the reasons that, while IBM’s stock has performed impressively since November of 2020, you probably haven’t heard very much about it. 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 $126.3 billion.
Earnings and Sales Growth: Over the last twelve months, earnings improve 6.88% while sales were 3.43% higher. In the last quarter, earnings increased more than 31.5%, while sales were 5.72% higher. IBM operates with a narrow operating profile relative to other stocks in the Tech sector; over the last twelve months, Net Income was 7.17% of Revenues and strengthened to 7.91% in the last quarter.
Free Cash Flow: IBM’s free cash flow is healthy; in the last quarter, it came in at almost $15.2 billion, a little below the $15.7 billion level of a year ago. That translates to a Free Cash Flow Yield of about 12%. 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 broader questions related to its data center business continues.
Debt to Equity: IBM has a debt/equity ratio of 2.21. 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 about $8.1 billion in cash and liquid assets (down from $14.2 billion in the third quarter of 2020) versus $48.7 billion in long-term debt.
Dividend: IBM pays an annual dividend of $6.56 per share, which translates to a yield of 4.64% 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 $150.50 per share. That means that IBM is only somewhat undervalued, by about 7% right now, and putting a useful discount price at around $121 per share.
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 upward trend from a November 2020 low at around $106 to its June peak at nearly $153; it also provides the baseline for the Fibonacci retracement lines on the right side of the chart. From that peak, the stock dropped back to touch current support near the 38.2% retracement line at around $135, and has rebounded in the last few days to a little above $140. Immediate resistance is at $142. A push above $142 should have about $4 of short-term upside, to about $146, with the stock’s 52-week high at around $153 acting as next resistance if bullish momentum picks up. A drop below $135, on the other hand should find next support between $131 and the 50% retracement line around $129.
Near-term Keys: IBM is an interesting company, with healthy Free Cash Flow as well as liquidity from available cash. The fact that liquidity has decreased over the last couple of quarters is a concern, but not a major one given their still-healthy Free Cash Flow and stable, strengthening Net Income profile. Even so, the stock’s increase in price since November means that I can’t call IBM a good value right now. For now, the best probabilities for success with this stock lie in short-term trading strategies. A push above $142 would be a good signal to think about buying the stock or working with call options, with a near-term target price at around $146, while a drop below $135 could be taken as a good signal to consider shorting the stock or buying put options, with an eye on $131 to 129 as a practical profit target on a bearish trade.