I Love IBM

In the year of the blue chip, no stock makes me blush redder than IBM (NYSE: IBM  ) does. Why? Business improvements:

Metric

Q1

Q2

Q3

Q4

Return on assets

6.0%

7.1%

7.9%

11.4%

Return on capital

11.2%

13.2%

14.8%

22.0%

Return on equity

20.8%

24.4%

26.2%

44.2%

Source: Capital IQ

That's extraordinary, especially when compared with peer Hewlett-Packard (NYSE: HPQ  ) , which has seen a renaissance of its own under CEO Mark Hurd:

Metric

Q1

Q2

Q3

Q4

Return on assets

5.6%

5.8%

5.3%

6.8%

Return on capital

10.2%

10.7%

9.6%

12.7%

Return on equity

13.4%

20.9%

15.0%

18.2%

Source: Capital IQ

You'd think that such improvement, driven primarily by expense management and a higher-margin software business, would have the stock trading for a premium. But that's not the case. According to Capital IQ, a share of IBM's normalized earnings trades for less than half of what it did in 2000.

What's more, growth is accelerating. After years in the single digits, analysts now say that Big Blue is capable of boosting its bottom line by 10.5% annually over each of the next five years.

If those projections hold up, the company could produce at least $8.83 in per-share normalized earnings by the end of 2011. Applying a multiple of 15 to earnings at that point -- low by historic standards -- results in a $132 stock. That's a 6% annual gain before IBM's 1.20% dividend yield.

But, again, that may be lowballing it. The firm remains the world's largest supplier of servers. Its once-dormant software business has also been reinvigorated by acquisitions funded through $11 billion in annual free cash flow.

Then there's the services team. While big competitors such as Accenture (NYSE: ACN  ) , BearingPoint (NYSE: BE  ) , and Infosys (Nasdaq: INFY  ) have done well in recent years, IBM is now investing billions in lower-cost regions like India to reduce the attractiveness of offshoring innovation.

Meanwhile, here in the U.S., executives are plowing cash back into Big Blue's research and development operation. That's encouraging. R&D is already a big strength, and has produced more patents than any other American firm over the past 13 years. Further expanding the labs could make it easier to sell high-rent consulting engagements on the topic of innovation while primping its software product line.

In the simplest terms, this 95-year-old has aged elegantly. Yet momentum investors, obsessed with sexier stocks, don't seem to care about IBM's improving fundamentals, cheap multiple to earnings, or growing competitive advantage.

I'd cry foul, except that great stocks like this don't come along often enough. With Big Blue, I'm smitten -- and I want her all to myself. Hands off.

What's sending Fools' hearts aflutter? Go back to our intro page to see what else we have a crush on.

Fool contributor Tim Beyers, ranked 1,123 out of more than 22,200 in Motley Fool CAPS, thinks his wife deserves the best growth stocks. Tim owns shares of IBM. All of his portfolio holdings can be found at Tim's Fool profile. His thoughts on growth stocks, Foolishness, and investing in general may be found in his blog. Accenture is an Inside Value pick. The Motley Fool's disclosure policy just sent your portfolio flowers.


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