Brutal bear markets tend to uncover value and this one is no different. Such markets also tend to drive investors into higher-quality companies as a way to preserve against losing too much money in the downdraft. For these reasons, today we chose to highlight the shares of International Business Machines (IBM) in our blog post.
Yesterday, IBM pre-announced a week ahead of schedule that its third quarter results were better than expected. This was a move to calm jittery investors who fear that miserable economic conditions—particularly in the finance sector—presage a very difficult IT environment in the coming months.
For the third quarter (July-September), IBM earned $2.05 per share, beating the consensus forecast of $2.01. Net income for the quarter was $2.8 billion, which was a twenty percent increase over the same period a year earlier. Sales increased five percent to $25.3 billion. However, netting out currency fluctuations, IBM’s third quarter sales increased only two percent. Analysts had initially expected sales of $26.5 billion, but had been lowering their forecasts before the earnings release. The faltering global economy and a strengthening dollar were cited as reasons for the reduced forecasts.
From Ockham’s perspective, IBM’s price-to-sales metric has historically traded in a range from 1.29x – 1.82x. Its current price-to-sales number is 1.28x. The stock’s historic price-to-cash flow range is 8.77x – 12.62x and the stock currently trades at a 31% discount to its average historic price-to-cash flow number. This is why we now rate the stock as Greatly Undervalued.
The global economy is clearly going to endure a rather rough patch. We see the signs of a synchronous global slow-down which will create a much more challenging environment for IT firms to operate in. The U.S. economy looks to be extremely dicey over the coming quarters and U.S. IT spending will certainly slow. Financial companies are some of the biggest spenders on IT and the turmoil affecting that sector will surely dampen IT spending by financial firms for some time. Also, IBM faces a bigger and more aggressive competitor in HP (HPQ) now that it has completed its acquisition of EDS.
However, in fearful market environments such as the one we are in, investors tend to find comfort in established names. IBM—“Big Blue”—is certainly such a name. After the destruction wrought upon the finance sector over the past few months, it is probably a safe bet that the finance sector will not be as dominant a component of our economic growth in the years ahead. Energy looks good for the long haul, but with the price of oil now on a downward trajectory, even the energy sector looks a bit problematic over the short-term. However, with broad global exposure and specializing in helping business increase its productivity, IT companies would appear to be well positioned to lead us out of the economic morass we find ourselves in and there are few companies better positioned to benefit from this than IBM. The shares, down thirty percent from their 52 week high (which tracks the S&P 500’s decline), appear increasingly attractive for patient, long-term investors.
Ockham Research does not own or trade in any of the securities mentioned in this article. However, Ockham Wealth Advisors an independent Registered Investment Advisor that utilizes the Ockham Research methodology and research does have a (long) position in HPQ. Ockham Research LLC does not stand to benefit monetarily from this relationship.
