IBM, the Tech Company That Can Do No Wrong

BOSTON (TheStreet) -- IBM (IBM), known as Big Blue, is among the most storied U.S. companies. The original "business machine manufacturer" pioneered computing and, then, in the 1990s, as it lost hardware market share to the likes of HP (HPQ), Dell (DELL) and Apple (AAPL), it reinvented itself as a global technology consultant.

Management, led by current CEO Sam Palmisano, has proven to be forward-looking, nimble and, more importantly, dedicated to rewarding shareholders. IBM's stock has returned 14%, annualized, since 2008, third best of the 30 Dow equities.
IBM

IBM was founded in 1911 as the Computing Tabulating Recording Corp. CTR's first products included a computing scale and a time clock to record workers' arrival and departure times. The original "electric tabulating machine" was invented by Herman Hollerith in 1889. It was refined and remodeled repeatedly in CTR's early years. A key turning point for the technology first-mover was the recruitment of Tom Watson Sr. in 1914. Watson, a manager at heart, bred and groomed one of the most dominant sales forces in American history by offering outstanding incentives and insisting on a rigid dress code and conduct policy.

Watson achieved the rank of president within 11 months and, within four years, had doubled CTR's net sales and expanded business to foreign markets, including Europe and South America. In 1924, the firm officially reformed its moniker to IBM. Under the leadership of Watson, IBM became an American powerhouse. When his son, Tom Watson Jr., took the reins in 1952, IBM was investing heavily in research and development, and had established laboratories across the country, which subsequently led to the creation of the first "self-learning" computer program, invention of the Fortran programming language and a newfound focus on information technology, which, at the time, had little appeal to traditional businesses.

IBM, although no longer considered a hardware company, is still among the most esteemed researchers in the country. It holds more patents than any other technology company, and its employees have won numerous Nobel prizes, Medals of Science and Turing awards. More relevant to readers, IBM's stock has been a consistent top performer and remains an attractive blue-chip investment. IBM is a so-called dividend aristocrat, having paid consistent distributions since 1913. The payout has grown 18% in the past 12 months and 18% and 27%, annually, over a three- and five-year span, respectively. However, the current yield is 1.6%.

Another standout attribute is IBM's return on equity, the critical measure of profitability for stock holders. The metric expanded to 64% in the latest quarter from 59% in the year-earlier period, exceeding the industry average of 53% and the S&P 500 average of 14%. IBM has goosed returns by using debt financing. It held nearly $29 billion of long-term debt at quarter's end, for a debt-to-equity ratio of 1.2. It has also been buying back stock, boosting shareholders' per-share earnings. The float fell 5.9% to 1.2 billion shares in the fourth quarter. Leverage and buybacks haven't damaged the balance sheet. IBM has $12 billion of cash.

IBM's commitment to shareholder returns has impressed equity analysts. The stock receives 18 "buy" recommendations and 13 "hold" calls from brokerages. It doesn't have a single "sell" rating. That aggregate score places the stock seventh in the Dow 30 for sentiment. However, with earnings season looming, it might be best to wait until after IBM's report, due April 19, to initiate a position. IBM's stock has dropped in response to five of its past six quarterly earnings reports, despite beating the consensus profit estimate for each period. Analysts forecast first-quarter earnings of $2.30, up 18% year-over-year, and sales of $24 billion, up 5.1%.

Fourth-quarter results were bolstered by overseas growth, a trend expected to persist over the long-term as emerging markets implement technology systems already ubiquitous in Western economies. IBM, as the leading tech consultant for businesses of various sizes, is a direct beneficiary of this trend. Geographically, IBM has leverage to Asian growth, generating 23% of its 2010 sales in the Asia Pacific region, 32% in Europe, the Middle East and Africa and 42% in the Americas, with 36%, specifically, from the U.S. It derived $56 billion, or 57%, of 2010 revenue from its services division, compared to 23% from its software unit and 18% from systems and technology.

Management is optimistic about growth through 2015, having recently forecasted $20 a share of earnings for that fiscal year, equivalent to a price-to-2015-earnings multiple of just 8.2. JPMorgan, which has an "overweight" ranking and $166 price target on the stock, believes IBM is in a unique situation as a "one-stop shop" for technology services and other large-cap tech competitors will be tempted to make large acquisitions, and potentially disrupt cash flow, earnings and operational efficiency, in order to diversify offerings amid elevated cash balances. IBM, on the other hand, has no need for a major acquisition and will continue to purchase pint-sized, easily-integrated companies, without altering its business model.

The name of the game in tech is cloud computing and IBM has an outstanding cloud franchise already, estimating $3 billion of incremental revenue growth from cloud through 2015. It also sees so-called smarter planet, its pro-environment, energy-efficient infrastructure and analytics platform, offering $7 billion of incremental revenue. Its core business analytics and optimization will thrive as the global economy integrates and expands. JPMorgan sees upside to the 2015 $20 EPS estimate, with upward pressure on IBM's margins as "servers, storage and networking take on increased importance in data-center-efficiency projects."

IBM's stock currently trades at a trailing earnings multiple of 14, a forward earnings multiple of 11, a sales multiple of 2 and a cash flow multiple of 10, discounts of up to 40% to IT-services-industry averages. Perhaps the greatest value driver for IBM isn't easily modeled by researchers. Its patent portfolio has nearly doubled to 5,090 since 2005, and it spends roughly $6 billion annually, or 6% of total revenue, on research and development, a hefty percentage.

-- Written by Jake Lynch in Boston.

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Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.

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