Big Blue Belongs in Your Portfolio

In the world of stocks, today's losers are often tomorrow's winners and vice versa.  The three top-performing stocks in the Dow Jones Industrial Average for 2013 are Boeing, Nike, and American Express. It would be difficult to argue that any of those companies are cheap, as each costs more than 20-times earnings. However, a superior investment opportunity exists with one of the worst-performing stocks in the DJIA -- IBM  (NYSE: IBM  ) .

Shareholder friendly management
When it comes to returning value to shareholders through buybacks and dividends, no company does it better than IBM. No member of the S&P Information Technology Index, a list that includes rivals Oracle  (NYSE: ORCL  ) and Hewlett-Packard  (NYSE: HPQ  ) , has consistently paid a dividend longer than IBM. A 45-year streak of dividend payments is something to admire. IBM only pays out 25% of its earnings as a dividend, so that streak won't be broken anytime soon. Dividends from IBM have grown more than sevenfold since the turn of the century. A big factor behind that dividend growth has been the company's huge share repurchases. Big Blue has reduced the number of outstanding shares by over 35% during past decade. The company also has more than $20 billion in planned buybacks, representing a further 10% reduction in outstanding shares at current prices..

Management receives a reasonable salary
In 2012, IBM CEO Gini Rommety's pay package totaled $16 million. That's in line with what Hewlett-Packard CEO, Meg Whitman, was paid, but tiny compared to the $96 million in options Larry Ellison received as his 2012 compensation. Companywide stock-based compensation during 2012 totaled $498 million for IBM, while Hewlett-Packard's 2012 total was $635 million. Not surprisingly, Oracle outdid them both, awarding employees more than $1.4 billion in stock-based compensation. Excessive compensation in the form of stock awards shows that Oracle prioritizes enhancing insider wealth over that of shareholders. Fortunately, such excessive compensation is not present at IBM.

Strong growth in the cloud
IBM is ahead of Hewlett-Packard when it comes to the cloud. Its July acquisition of SoftLayer Technologies contributed to strong growth in IBM's cloud computing operations. Its latest 10-Q revealed that the company grew cloud revenue by 70% year-over-year, and for the first time generated more than $1 billion in quarterly revenue from the cloud. That's more revenue than Hewlett-Packard generates from its entire software segment, which includes the company's cloud-based applications. Additionally, HP announced declining revenue from its IT and cloud management products in its latest quarterly report. Gauging Oracle's cloud performance is difficult because the company lumps cloud software sales with sales of traditional software products. While it would be unwise to draw conclusions from this as to Oracle's success in cloud computing, it makes one curious. Why does Oracle conceal what percentage of its software revenue and profits come from cloud-based applications?

Promising results from growth initiatives
Two of IBM's growth initiatives, besides the cloud, are Smarter Planet and business analytics. Revenue from business analytics grew 8% year-over-year for IBM. The company's Smarter Planet initiative is one of the coolest things any company on Earth is doing to improve how efficiently resources are used. IBM's Smarter Planet solution utilizes the company's analytical capabilities to expose inefficiencies in electrical grids, hospitals, highways, and more. The social utility provided by these solutions is simply stupendous. Providing that utility translates into financial rewards for IBM, revenue from Smarter Planet solutions has grown 20% year-over-year.

Foolish bottom line
Shares of IBM have sat out during the market's recent rally. Luckily for investors, this means they can still be obtained for a very reasonable price. Management at IBM is incredibly friendly toward shareholders, showering them with dividends and buybacks. The company's initiatives for growth in a rapidly evolving technological environment are producing promising results. Don't let short-term revenue figures cloud your judgement. In the coming decades, few companies will provide societal benefits of a magnitude equaling IBM's. Mr. Market is offering all of that for less than 13 times earnings, and in my opinion you would be wise to accept. 

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  • Report this Comment On December 03, 2013, at 6:37 AM, galton wrote:

    But IBM lost a $600 million cloud contract with the CIA to Amazon. Also, highly respected Stanley Druckemuller downgraded them for falling behind in cloud competitiveness. Not good signs.

  • Report this Comment On December 03, 2013, at 10:12 AM, KenLuskin wrote:

    ****IBM cannot benefit from the Cloud, because competing with Amazon will KILL their profits.****

    1)The CLOUD requires much less IT equipment and software to support the combined needs of all the companies that have been buying from IBM and other old line equipment and software companies. IBM equipment sales and margins are in free fall. Software is just holding on, but it too will succumb.

    2) CLOUD service margins will be low single digits, because that is how Amazon grows, while keeping out competitors.

    3) IBM currently has 20% net profit margins.

    4) Therefore, the more Cloud service business that IBM wins, the lower their overall net profit margins.

    5) Since IBM is the LARGEST Info Tech (IT) service company in the world, IBM will suffer from continually lower margins year after year. Warren bought into IBM because he thought that the "service" business was a moat against technology obsolescence. The cloud will destroy the high margins and large cash flow of the service business. The IBM service business has long term contracts, which are only temporarily insulating it from the cloud competition.

    Almost all the revenues at IBM depend upon the service and consulting businesses of IBM. When most companies decide to use Amazon Web Services, they no longer need IBM services, IBM consulting, IBM software, and IBM hardware.

    6) The IBM hardware sales decline is the canary in the coal mine. The first thing a company does before they switch to the cloud is stop buying equipment for their IT dept. Service and consulting are longer term contracts. Software has a long tail from maintenance contracts.

    7) Amazon can buy hardware and software and provide it to ALL their customers on a rental basis. Therefore, there the number of software licenses sold will decline dramatically. When companies decide they no longer need software support from IBM, they will stop buying maintenance.

    8) The public cloud is still only in its infancy, and is only a small percentage of the total compute supply. As the cloud continually grows to become a majority of computing supply, IBM margins will continue to decline.

    9) Most of Warren's best investments are based upon business models that are called franchises. IBM had a franchise in IT service. That franchise is being destroyed by the cloud.

    ITS ELEMENTARY... my dear Watson!

  • Report this Comment On December 04, 2013, at 10:58 AM, Momintn wrote:

    The Street re-iterated their buy rating on IBM today.

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