IBM Intrinsic Value · IBM has a low P/E which makes it attractive to potential investors as the...
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Intrinsic Value Assessment of INTERNATIONAL BUSINESS MACHINE (IBM) September 27, 2017 This article was written in collaboration with Eoin O'Byrne a friend of The Investor’s Podcast This assessment was conducted from the tools provided in Preston and Stig’s Intrinsic Value Online Training Course. Introduction International Business Machine (IBM) is a significant component of the tech industry, but it is not part of the illustrious FANG stocks that propel this market segment’s growth. Three of these stocks were unpursued opportunities and major regrets of Charlie Munger and Warren Buffett. Meanwhile, investing in IBM was another regret of these investors. Over the past 52-week period, the price band for IBM has been between $182.79 and $139.13. The stock currently trades at around $145 -- above this low point recorded in August. This stock is languishing at some of its lowest levels since 2010. IBM’s Intrinsic Value The company has maintained a steady cash flow over the last 10-year period. This consistency is essential for a potential stock pick as it shows a company that can maintain and control its earnings while keeping an eye on consistent growth. Free cash flow (FCF) per share was at its highest level in a decade in 2016 at $15.02 a share, showing steady and controlled FCF. Using a projected cash flow, setting 2007 as the base, and following the theory of reversion to the mean, I have estimated a potential FCF. Using an upper, middle, and lower band, we can potentially see the projected value of this stock. My projection of the upper band is 5% growth based on an increased trend of this remarkably consistent cash flow generating company. The likelihood of this band being achieved over the next ten years was set at 10%. This percentage was reached based on current macro climates in which we are in the second-longest bull market. Meanwhile, its probability of lasting another decade was in decimal percentages.
Transcript of IBM Intrinsic Value · IBM has a low P/E which makes it attractive to potential investors as the...
Intrinsic Value Assessment of
INTERNATIONAL BUSINESS MACHINE (IBM)
September 27, 2017 This article was written in collaboration with Eoin O'Byrne
a friend of The Investor’s Podcast
ThisassessmentwasconductedfromthetoolsprovidedinPrestonandStig’sIntrinsicValueOnlineTrainingCourse.
IntroductionInternationalBusinessMachine(IBM)isasignificantcomponentofthetechindustry,butitisnotpartoftheillustriousFANGstocksthatpropelthismarketsegment’sgrowth.ThreeofthesestockswereunpursuedopportunitiesandmajorregretsofCharlieMungerandWarrenBuffett.Meanwhile,investinginIBMwasanotherregretoftheseinvestors.
Overthepast52-weekperiod,thepricebandforIBMhasbeenbetween$182.79and$139.13.Thestockcurrentlytradesataround$145--abovethislowpointrecordedinAugust.Thisstockislanguishingatsomeofitslowestlevelssince2010.
IBM’sIntrinsicValueThecompanyhasmaintainedasteadycashflowoverthelast10-yearperiod.Thisconsistencyisessentialforapotentialstockpickasitshowsacompanythatcanmaintainandcontrolitsearningswhilekeepinganeyeonconsistentgrowth.Freecashflow(FCF)persharewasatitshighestlevelinadecadein2016at$15.02ashare,showingsteadyandcontrolledFCF.
Usingaprojectedcashflow,setting2007asthebase,andfollowingthetheoryofreversiontothemean,IhaveestimatedapotentialFCF.
Usinganupper,middle,andlowerband,wecanpotentiallyseetheprojectedvalueofthisstock.Myprojectionoftheupperbandis5%growthbasedonanincreasedtrendofthisremarkablyconsistentcashflowgeneratingcompany.Thelikelihoodofthisbandbeingachievedoverthenexttenyearswassetat10%.Thispercentagewasreachedbasedoncurrentmacroclimatesinwhichweareinthesecond-longestbullmarket.Meanwhile,itsprobabilityoflastinganotherdecadewasindecimalpercentages.
Intrinsic Value Assessment of
INTERNATIONAL BUSINESS MACHINE (IBM)
ThisassessmentwasconductedfromthetoolsprovidedinPrestonandStig’sIntrinsicValueOnlineTrainingCourse.
Themiddlebandwascalculatedthroughreversiontothemean,anditslikelihoodwassetat65%withalevelofgrowthof0%.Finally,thelowerbandwassetat-5%whichwasthelargestleveldroppedovertheperiod.Alikelihoodof25%wasgiventothisband.Igavesuchalikelihoodbasedonhowlongthispeakinthecyclehasbeendrivenbytechandhowapotentialrecessioncouldadverselyaffectthiscompany.
Thebusinesshasbeenstagnatedforquitesometime,andthelargestrevenuesegmentsareunderalotofpressure–perhapsevenfacingalong-termdecline.Havingcalculatedthis,IbelieveanInternalRateofReturnof7.8%canbeachievedoverthenext10-yearperiod.
IBMhasalowP/Ewhichmakesitattractivetopotentialinvestorsasthecompanyisnotoverpriced.Currently,IBMhasaP/Eof12.1whiletheindustryaverageis18.1.ThismeansIBMcosts$12.1toearn$1basedonthecompany’searningsgeneratedoverthelast12-monthperiod.Asyoucanimagine,thelowerthisgoes,themoreattractivetheownershipofthiscompany’ssharesaretoavalueinvestorastheyareseentobetradingatadiscount.AnotherattractivefeatureofIBMisthequarterlydividend,whichiscurrentlya4%annualdividendyield.Thiscanbequiteahealthyyearlystipendforthoseinvestinginthestockforthelonghaul.Thepayoutratioof43.5%translatestoa$6dividendpershare.Thegrowthofthedividendhasbeenincreasingfor17yearssince2007andhasbeencontinuouslypaidsince1913.
IBM’sCompetitiveAdvantageAfeatureofIBMthathasthepotentialtoraisethiscompanybackupfromitsslowdeclineasamajorplayerisWatson,theAIandsophisticatedanalyticalsoftwaremachine.Thismachineisaimedatenhancingcompaniesandimprovingtheiroverallperformance.CEOGinniRomettysaysWatsonwillperformina“vertical”fashion.Inotherwords,itwillbetaughtthroughalgorithmicprogrammingtoworkeffectivelyandinabespokemannerfortheuser,i.e.thecompanyowner.So,Watsonwillnotonlybeoneproduct.Itwillactasauniqueoperatingsystemandanalyticproblemsolverforeachcompany.Thiswouldessentiallycreatea“myAI”typeofproduct,asRomettysaidduringarecentinterview.Thiscreatesasituationwherecompaniescanhaveanever-evolvingalgorithmthattheycangrowanddeveloptodetectanyfinancialfraudinthecaseofabankorselectsitesforpotentialdrillingforoilcompanies.Thisoneproductcanbecometheultimateinternationalbusinessmachine.Theareasofcognitivesolutionsandcloudplatformsshowgreatreturnsforthecompanyandamountto43%oftotalrevenue.
Intrinsic Value Assessment of
INTERNATIONAL BUSINESS MACHINE (IBM)
ThisassessmentwasconductedfromthetoolsprovidedinPrestonandStig’sIntrinsicValueOnlineTrainingCourse.
AnotherareawhereIBMcouldbeapotentialleaderisinblockchaintechnologies.Currently,IBMisleadingthechargeandisseenasbeingbetterequippedandpreparedthanrivalslikeMicrosoft.Thismarketspaceisnewandanythingbutcertain.Asapioneerinthisarea,however,IBMhastheopportunitytocreateandestablishbrandloyaltyamongfutureusersofthispotentiallydisruptiveemergingmarketspace.Thisbrandloyaltyisamajormoatthatthecompanycurrentlypossessesandcontinuallymaintains.
Infocusingonwherethecompanyisheading,wemustlookatwhereIBMhascomefromaswell.Attheendoftheday,IBMhasaverystrongmoat,andthatisitsbrandpower.Traditionally,thenameIBMissynonymouswithreliabilitynotonlyinitsproductsbutalsowithitsreputationasacompany.Whilethecurrentslowdowningrowthandthecurrentmanagementhavenotimprovedtheirreputation,IBMcanstillbeconsideredastrongbrand.Thecompanyhasastrongpresenceinitscorebusinessoftechnologyhardwareamongmanylargecompanieswithmainframesandotherofficetechs.Themovementtocloudstorageisstillmanyyearsawayfromtotaldominance.Atthismomentintime,themajorityofstorageisstillphysical,andIBMhasthatareasewnupwithacontinuedrevenuesourcestemmingfromit.Yes,therewasmostcertainlyareductioninrevenuefromhardwareamountingto$2.1bnin2016down9%fortheyear.Otherareassuchasglobalbusinesssolutionsandcognitivesolutionsaccountformorethan50%ofIBM’srevenueannually.Thisshowsthatthisareaofthebusiness,whereitisoftencriticizedforbeingoutoftouchwiththemoderneraoftechnology,isgeneratinganenormousamountofrevenueforthem.
IBM’sDrawbacksThiscompanyisnotwithoutitsnegatives.AmajorstumblingblockinthewayofIBMiswhatcomesupassoonasyousearchthecompanyonGoogleandthatisWarrenBuffettandCharlieMunger’sdisappointmentintheirinvestmentinthecompanyandhowtheyregrettheirinvestment.Thisisobviouslynotanimageanycompanywantstobeassociatedwith.
Thecompanyisalsoaggressiveinitspursuitofstockbuybackswhilecreatingstockintheformofcompensationtoemployees.Since1999,IBMhasrepurchased75millionsharesonaverage.Thisstaggeringamountofbuybacksisconstantandplannedalmostlikeadollarcostaveragingapproachbyaninvestor.Thisapproach,however,hasnotyieldedthedesiredreturnsasthevalueofthestockhasnotkeptupwithinflationandwasmorethan70%offinkeepingtrackwiththeinflationratesfrom1999to2016.ThisapproachhasbeenconsistentacrossallthreeCEOswithinthistimeframe.ThislackofchangefromaplanthatisnotyieldingthedesiredeffectisaworryingtraitwithinIBM.Theirdecisionmakingcandefinitelybequestionedinthisinstance.
ThevastarrayofcompetitorsacrossdifferentmarketspacesthatIBMworkswithinaresignificantfactorsaswell.Incloudcomputing,youhaveAmazonandGoogle.Inanalytics,thereareOracleandMicrosoft.Thislevelofcompetitioncanbegreatandspuringenuity.However,itappearsthatIBMiscomingoutsecondbestinthesematchups.Moreover,thistrendmaycontinueunlesstheyfindawaytobecomethetopdog.Meanwhile,competinginsomanyareasmeansthatfullattentioncannotbegivenspecifictasks.Thiscanbeahindrancetoexcellence,meaningIBMgetscaughtbetweencontinuingtheirlegacytechhardwarebusinessandinnovatingincloud/analyticservices.Thisisgettingreflectedintheirreturnstodate.Theirtotalreturnsrecentlyarelanguishingbehind--InfoTechServicesisup5.73%whileS&Pisupover18%YTDandIBMare-9.05%.TheseworryingfiguresareperhapsshowingIBM’slackofabilitytocompetewiththeirmajortechstocksrivals.
SummaryTheslowerosionofIBM’scorebusinessaspectsisanareaofworry.Lastyear,earningspersharedropped9%.ThisareaofIBMissuchalargerevenuegeneratorthatsuchafallissomethingtothinkaboutwhenappraising.Withthatinmind,returnswillnotbeseenforalongtime.However,itstillhasmanyfeaturestomakeitacompellingbuyandholdsituation.Withtheshort-termdrawbacksandthelong-termpotentialforthis
Intrinsic Value Assessment of
INTERNATIONAL BUSINESS MACHINE (IBM)
ThisassessmentwasconductedfromthetoolsprovidedinPrestonandStig’sIntrinsicValueOnlineTrainingCourse.
companyinWatsonalongwiththeirentryintotheblockchainmarketplace,Iseethiscompanybeingatasatisfactorylevelforfuturegains.
Withthesteadyinflowcreatedbythedividend,itlendsitselfwelltoalong-terminvestment.Letmeexplainitusingthisexample:IfyouholdoneshareofIBMfor10yearsanditfallsto$90ashare(37.5%drop),youwillhavecomeoutwithapositivereturnduetothecontinuousdividendthathasbeenincreasingforthelast17years,whichincludedthetechbubbleburstingandthefinancialcrash.
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madefromusingthisassessmentorthetoolsmentionedintheassessment.
