Is This Tech Behemoth a Long-Term Buy When Market Anxiety Calms?

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Tech giant IBM (NYSE:IBM) made the business news a short time ago with their $1.3 billion dollar acquisition of HR (Human Resources) software provider Kenexa (NYSE:KNXA).  Kenexa sells recruitment and talent management software to an impressive list of clients but more importantly for IBM. KNXA is heavily into cloud computing.  This fits well into IBM’s latest efforts to reinvent itself yet again, eliminating much of their hardware presence.  The company’s 2012 2nd Quarter earnings beat on earnings but missed on revenues due to diminishing demand for its flagship IT services business.

So what is going on with IBM right now?  Is this early tech leader a BUY, a WAIT and SEE, or a STAY AWAY?

Let’s analyze the stock with the relevant sections of our CHEAT SHEET investing framework.

C = Catalyst for a Stock’s Movement

Company management attributed the revenue decline to a variety of factors relating to global macroeconomic conditions.  They get about 60% of their revenue outside the US and they saw a 9% drop in revenue from Europe, the Middle East, and Africa.  In addition, they got hit hard by the weakening Euro and other fluctuations in foreign exchange rates.  The implication here is that any real positive signs of a long term solution to the European debt crisis could act as a catalyst for the stock price.

H = High Quality Pipeline

IBM has been on something of an acquisition binge over the last several years as part of their strategic effort to shift emphasis on hardware offerings like mainframe computers and servers to higher-margin services and software. They recently announced delivery of an improved mainframe computer which is expected to lead to increases in the ancillary service in which they have greater interest.  But the new product to watch is Watson.

Watson is the artificially intelligent mainframe computer that got a lot of buzz by competing against humans in the game show “Jeopardy.”  Watson won and IBM (NYSE:IBM) is already moving the system’s capabilities into the field of medical diagnosis and large scale financial transaction processing.  Healthcare solutions provider WellPoint (NYSE:WLP) and Citigroup (NYSE:C) are already on board.

A more exciting use of Watson is in the mobile space.  Bloomberg recently reported IBM is working on technology to incorporate Watson into smartphones, which would have processing capabilities far beyond Apple’s (NASDAQ:AAPL) celebrated Siri personal assistant.

E = Equity to Debt Ratio is Close to Zero

This is the one area that might cause investors concerned about the possibility of another global credit freeze some pause.  The bill for IBM”S acquisitions continues to mount.  The company’s debt to equity ratio is outsized at 1.58 or 158%.  Total debt as of the most recent quarter was $32.44 billion with $11.23 billion cash on hand.  In contrast rival Intel (NASDAQ:INTC) has a debt to equity ratio of .15 or 15% and total debt of $7.23 billion.

A = A Level Management Runs the Company

A little more than a decade ago some viewed IBM as a century old dinosaur whose time had come and gone.  Beginning with the sale of its PC operation to Lenovo in 2005, the company has gone through a successful restructuring into what many analysts believe is now the most powerful player in its sector.

T = Technicals on the Stock Chart are Strong

Over the course of the last year IBM’s share price has been trending upward with occasional dips below its 20 Day SMA (Simple Moving Average); its 50 Day SMA; and its 200 Day SMA.  As of August 928h 2012 the share price was 1.12% below the 20 Day SMA; 0.91% above its 50 Day SMA; and 1.39% above its 200 Day SMA.

S = Support is Provided by Institutional Investors & Company Insiders

IBM is 59.81% institutionally owned.  The top five holders are Berkshire Hathaway, Vanguard, BlackRock, State Farm Insurance, and Fidelity.  Insider transactions over the last six months show 23 Sell transactions with only 1 Buy transaction.  It can be difficult to determine insider selling that represents declining confidence in a company’s future and routine selling to take profits, much of which is done by insider trust funds.  One way to check this is to look at options exercises for the listed insiders who have sold share.  A better measure is to check the SEC filing forms to see the number of shares remaining after the sale.

E = Earnings are Increasing Quarter over Quarter

Although IBM has slipped a bit on this measure over the past year, their longer term performance is impressive.  Going back 22 quarters, they have shown double-digit increases in earnings in 20 out of 22 reporting quarters.

E + Excellent Relative Performance versus Peers and Sector

Return on Equity (ROE) is a favored measure for value investors.  On a trailing twelve month (NYSE:TTM) basis IBM’s ROE stands at a lofty 77.4%.  None of its major competitors come close.  Oracle (NASDAQ:ORCL) has an ROE of 23.67%; Microsoft (NYSE:MSFT) is at 27.51%; Intel (NYSE:INTC) shows an ROE of 25.42%; and Cisco (NASDAQ:CSCO) is 16.32%.  Although not yet a direct competitor, market darling Apple (NASDAQ:AAPL) has an ROE of 44.32%.  IBM’s five year average ROE is 59.73% compared to its sector average of 22.48%.

T = Trends Support the Industry in which the Company Operates

IT infrastructure is booming and IBM stands to benefit at every point in the cycle.  Their business analytics, cloud computing, and smarter planet efforts, and new hardware offerings cover the waterfront quite well.

Conclusion

With a share price rise of about 16% year over year and 5% increase year to date, some analysts brand IBM with the ran up too far too fast tag.  However, given long term growth in the technology sectors where IBM operates it is hard to think of this company as anything but a BUY.  At worst, if you believe in the many doomsday prophecies bouncing around these days, you might put IBM on a WAIT and SEE list for buying once the smoke clears.

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