Buy global tech stock IBM despite recent price gains

US blue chip stock IBM’s shares have jumped since it reported better-than-expected third-quarter results. Even so, it should do better. We continue to rate the company’s shares a buy for further long-term price gains as well as attractive and growing dividends.

Global_Tech_StockWe rate New York State-based US global tech stock International Business Machines (NYSE—IBM) a ‘buy’. Ours is a minority view. The consensus recommendation of 11 analysts is ‘hold’.

IBM reported better-than-expected third-quarter results. As a result, its shares jumped substantially. After this run-up, however, you may wonder whether we should have changed our advice.

IBM is making progress on implementing strategies to revive its earnings. The shares remain well priced. The company’s dividend yields an attractive 3.7 per cent. What’s more, it has raised its dividend for many years in a row. In short, we continue to rate IBM a buy for further long-term share price gains as well as attractive and growing dividends.

IBM’s earnings per share declined in 2015 and 2016. This year, it expects to earn “at least $13.80” a share. Even if the company earns only $13.80 a share, that would represent earnings per share growth of 1.5 per cent. That’s slow, of course. But at least it’s now going in the right direction.

We expect IBM’s earnings to grow faster

More important, we expect IBM’s earnings growth to accelerate. That’s thanks to six ‘strategic imperatives’. Over the 12 months to September 30, this revenue advanced by a fast 10 per cent, to $34.9 billion. That now accounts for 45 per cent of the company’s revenue. Over the previous 12 months, its cloud revenue jumped by 26 per cent, to $15.8 billion.

Chair, president and chief executive officer Ginni Rometty said: “In the third quarter we achieved double-digit growth in our strategic imperatives, extended our enterprise cloud leadership, and expanded our cognitive solutions business.” (The cognitive solutions segment includes solutions software and transaction processing software.) Ms. Rometty added: “There was enthusiastic adoption of IBM’s new z Systems mainframe, which delivers breakthrough security capabilities to our clients.” Given high-profile hacker attacks in recent months, greatly improved security should hold high appeal for clients.

IBM expects its 2017 free cash flow to change little. (Free cash flow is cash flow less capital spending.) Still, it remains what the company calls ‘strong’. Senior vice president and chief financial officer Martin Schroeter said: “During the first three quarters of the year, our strong free cash flow has enabled us to maintain our R&D [Research and Development] investments and to expand IBM’s cloud and cognitive capabilities through capital investments. In addition, we have returned nearly $8 billion to shareholders through dividends and share repurchases.” In the first nine months, IBM paid dividends of $4.119 billion and spent $3.674 billion buying back its shares.

IBM can afford to reward its shareholders

Besides strong free cash flow, IBM has a sound balance sheet. On September 30, it held cash of $10.915 billion and short-term investment of $600 million. Its net debt-to-cash-flow ratio is a safe 2.06 times, particularly given its diversification across product lines and geographic regions.

IBM operates around the world. This makes it safer by reducing its risk in any one country. In 2016, IBM generated 48 per cent of its revenue in the Americas (North, South, Central and the Caribbean); it generated 29 per cent in Europe, the Middle East and Africa; and it generated the other 23 per cent of its revenue in the Asia-Pacific region.

IBM’s shares look well priced. Based on this year’s conservative earnings estimate of $13.80, the shares trade at a price-to-earnings ratio of 11.7 times. That’s reasonable and below the market’s multiple. ‘Big Blue’ (a nick name first attached to the company in the 1980s) remains a blue chip stock to buy for further long-term share price gains as well as attractive and growing dividends.

This is an edited version of an article that was originally published for subscribers in the November 3, 2017, issue of The Investment Reporter. You can profit from the award-winning advice subscribers receive regularly in The Investment Reporter.

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