IBM Is an Investor's Best Friend: Fund Manager

BOSTON ( TheStreet) -- IBM ( IBM), set to report earnings after the close today, could be the cornerstone of a portfolio for every investor thanks to the company's dramatic transformation over the last few years, one mutual fund manager says.

Founded 100 years ago, IBM has transitioned from a maker of tabulators and time recorders to hard disk drives and ATMs to consulting services and artificial intelligence programs. Despite the sweeping change of product offerings and services over the past century, IBM has been a stable rock for investors of all kinds.

"The stock makes sense for a broad array of investors," says Tom Villalta, manager of the Jones Villalta Opportunity Fund ( JVOFX). "There are a lot of things to like about IBM. It has wide appeal. This is a company that has continued to deliver."

In addition to stability, IBM's stock offers investors ownership of a company with a relatively low debt burden, a solid backlog of business and a strong position in the information technology industry. Villalta says that IBM, one of his 35 holdings, represents 4% of the portfolio, making it one of his fund's largest positions.

While investors have been trained to measure a company's earnings per share and revenue against analysts' estimates, a bigger focus should be on IBM's major improvement in gross margins. IBM has boosted its gross margin from 37% a decade ago to above 46% last year. Analysts are forecasting the IBM's gross margin will rise to 46% in its second quarter from 44.5% last quarter and 45.6% in the year-ago period, according to a poll by Thomson Reuters.

"They've really repositioned the company to take advantage of more differentiated product offerings and getting out of more commodity-like businesses," Villalta says. "The move into services makes it easier for IBM to differentiate itself. It allows for higher margins and higher returns on equity. We really like that and it supports a higher valuation."

>>For upcoming earnings and estimates, see our Earnings Calendar.

One-hundred-year-old companies are rarely thought of as growth companies, but Villalta makes a case for IBM as an attractive growth play. "It's a classic growth stock at a reasonable price," he says. "It's something you can buy and hold onto for a number of years and experience growth in the U.S. economy."

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But not all analysts agree. Kulbinder Garcha of Credit Suisse has a "neutral" rating on IBM ahead of the company's second-quarter results. Garcha argues that at 12 times 2012 earnings, the stock should trade at a discount to the S&P 500 as IBM has over 50% of incremental earnings per share coming from mergers, acquisitions and buybacks over the next five years.

"The quality of growth is somewhat low," Garcha writes of IBM in a research note. "While enterprise momentum should provide a tailwind, we see limited room for upside."

Villalta, on the other hand, says that is investment in IBM is predicated on the stock's valuation. "It may seem a little strange to have a company with a price-to-book ratio in excess of 7 and call it an undervalued stock, but you're talking about a company that has evolved significantly over the last few years," Villalta says.

He points out that the company had return on equity in the range of 30% to 35% between 2000 and 2005.

"Now, you're looking at returns on equity above 45% on an ongoing basis," Villalta says. "From our perspective, it's undervalued as a very reasonably priced, growing business at a very fair valuation."

Villalta and his firm, which has about $45 million in assets under management, are bullish on a lot of big technology companies now, with information technology the second largest position for the firm. In addition to IBM, Villalta owns Intel ( INTC), Microsoft ( MSFT), EMC Corp. ( EMC) and Oracle ( ORCL).

"All of those stocks are very reasonably priced given the short to intermediate term growth prospects. I would be comfortable holding all of them," Villalta says.

While all of these large-cap tech names have gone from growth stocks to companies that generate an enormous sum of cash flow, IBM stands out from the crowd for a number of reasons, Villalta says.

"The big differentiator here is that IBM learned a long time ago to have a disciplined process for returning cash to shareholders while growing the business," he says. "It pays a lot of dividends, figuratively speaking, over time with an improved share price. Microsoft and Intel are just starting to learn they need a more disciplined method for returning cash flow to shareholders. It's no longer all about growth."

-- Written by Robert Holmes 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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