Stock of the Week
NYSE Symbol: IBM
Price as of 4/17: $160.67
Not to sound like a broken record, but the major averages have entered the seventh year of the bull market (not sure if we've ever been up 7 straight years) without a 10% correction since 2012. It's safe to say this rally is getting long in the tooth and the fundamentals don't look pretty in the short term. With earnings season in full swing we'll know in short order if the earnings will justify current valuations. The current earnings estimates are being retched down due to slower growth. The energy sector has the worst earnings projects yet investors continue to give the sector the benefit of the doubt that things will rebound. If not, then there will definitely be another leg to the downside. At the end of the year we highlighted the dogs of the Dow. Since then Boeing has jumped 14%, the best performing Dow component this year. GE has come to life up 5.7% thanks to a corporate restructuring that will add $90 billion to the dividend and share buybacks in the coming years. Exxon and Chevron are a work in progress. Neither has the cash flow to pay their dividend and capital expenditures, but once again investors have not been fazed. You may want to stay on the sidelines a while longer with these two. The last dog of the Dow back in December is this week's featured stock, IBM. Big Blue has been a dog for three-and-a-half years down 8% versus the Dow's 63% rise. However since we featured the stock it's only down $2 or 1% verse the Dow's unchanged year to date return. In the last six months the stock has been in a tight range between $165 and $150, building a base while giving management time for their cloud computing business plan to develop. IBM is not a growth stock, but in a market trading for a high valuation, buying a stock trading at 10 times reduced estimates is a safe way to play the markets in the short term. In the long term, IBM has a long history of getting things right and rewarding shareholders handsomely.
IBM will report earnings tomorrow night so cautious investors may want to wait and see the earnings. In the short term, the earnings for IBM will be lousy. The company continues to face negative growth even with the billions spent on share buybacks. IBM could take a page from GE's playbook and announce an unforeseen restructuring at any time. In the last year, IBM sold three units that produced $7 billion in sales but lost about $500 million. Long term, IBM's goal is get their cloud computing business corrected. As highlighted in Barrons over the weekend, IBM's 2014 cloud business grew 60% to $7 billion. The company, which expects to operate 46 cloud centers by the end of this year, projects the cloud industry opportunity at $400 billion by 2018. A vote of confidence came last year from Apple which chose IBM to help it penetrate the mobile enterprise applications business. Cloud computing will also help IBM's big data and analytics, mobile, social, and security software divisions. IBM expects these businesses to grow to $40 billion by 2018, or 40% of sales. Hardware sales continue to struggle, but only account for 11% of total sales. A new server cycle could start soon boosting the stagnate division. One positive from hardware is the add-on software sales it generates. IBM's service revenue backlog stands at an impressive $128 billion. Add these positive developments together and IBM's future is finally looking a little brighter.
The current valuation, unlike the broader market, is only accounting for the negatives at IBM and none of the potential positives. IBM trades for 10 times reduced earnings and 9 times 2016 earnings which very well may be ratcheted higher in the coming year. IBM also trades for 1.2 times sales and sports a dividend yield of 2.7% above the Dow and S&P 500 dividend yield. In the short run, IBM's catalysts seem to be a ways down the road, but IBM looks to be a better risk reward in this overpriced market with good long term potential to turn back into the IBM we all know and love.