The company is a survivor of numerous economic downturns, and the current malaise offers executives the potential to wring out efficiencies from processes that, like many businesses in the go-go days earlier this decade, may have become bloated. So IBM may become more efficient. The company has excellent fundamentals and displays high quality in its metrics, such as return on equity (averaging 30% over the past 10 years) and wide and consistent margins (averaging around 40%, 13% and 9% for gross, operating and net margins, respectively). IBM is a perennial favorite with both institutional and private investors.
Despite its strengths and storied history, IBM is as susceptible to economic woes as any other company, which has been borne out in the past two recessions, in 2001 and in 1990. In the early 1990s, the company posted losses. However, IBM rebounded in both cases and will do so again.
This may be the ugliest recession that IBM has ever faced. The current economic situation is so bad that it is frequently compared to the Great Depression. Today's turmoil is spread across industry sectors and international boundaries. It is a global meltdown of significant magnitude. Big Blue will be sorely tested, and its share price is almost certain to fall, as it did in 2001 and 1990.
That said, the past performance of IBM's stock is of no real importance when looking out two or three years. The reality is that there is a budget freeze in nearly every type of corporation around the planet, despite IBM management's assertion that long-term contracts will uphold margins. It may take considerably longer than a year for corporations to come back on line for IBM's products and services. So it's difficult to believe management's upbeat forecasts. History points to Big Blue as recession-sensitive.
The stock has fallen 22% this year, which is not too bad given the troubles in the market. However, the 52-week range is $79 to $131, a 40% swing. It is quite reasonable to suggest that this stock has a valuation range of around $70 to $90, based on IBM's past earnings and performance. In the 1987 to 1990 recession, the stock fell close to 70% from its high -- down from about $45 to $15. In 2001, it dropped from approximately $135 to $50, a 60% decline. The 2001 recession was milder than what we will experience soon, so IBM could trade down from its high of $131 to levels below $50.
There are strategies that IBM is implementing that address the current downturn, such as introducing lower-cost products and providing easier financing for customers. But the rationale that corporations will still buy IBM's products to increase efficiency and reduce operating costs during the downturn is similar to what was said in 2001 but never happened.
The Street.com ratings gives IBM a B-minus rating, down from the start of the year, when it held a B-plus rating. Our models may further lower IBM's rating as we move into next year.
Sam Patel, CFA, is the manager of mutual fund research for the TheStreet.com Ratings.
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