With the stock market at record highs, and the Federal Reserve's quantitative easing program at an end, you might think investors would be growing nervous about stock valuations. They're not.
In fact, corporations think shares are so cheap that they're willing to spend billions (and more billions) of dollars buying back their own stock. Case in point: Earlier this week, IBM (IBM -0.47%) announced plans to plow $5 billion into repurchases of its own shares.
Is this a savvy financial move to buy undervalued shares, or a misguided attempt by management to shore up IBM's plummeting stock price? We'll find out by asking two basic questions.
Can it pay?
Easily. According to S&P Capital IQ figures, IBM has $9.56 billion in cash on its books. That's enough moolah for IBM to conduct its entire buyback tomorrow, it it so chooses -- and then do a buyback of similar size again the next day.
On the other hand, IBM also carries more than $32.8 billion in long-term debt on its books, meaning that net-net the company is actually in a pretty deep whole, with $23 billion more debt than cash to its credit. Moreover, in IBM's last debt offering, in February, the company was forced to pay a higher interest rate (3.625%) on its 10-year bonds than it received for a similar offering in July 2013 (3.375%) -- and way more than the 1% it paid in interest on an historic offering of three-year notes back in 2010.
Should it pay?
While corporate debt is still cheap, it's getting more expensive. That being the case, investors can certainly question whether spending $5 billion on share buybacks is really the best use of IBM's cash, here in the shadow of a $32.8 billion debt load.
Of course, buying back shares could still be a good idea, if IBM is getting a good deal on the shares. So let's next look at how IBM stock's valuation stacks up against its peers':
|
P/E |
Dividend Yield |
5-Year Projected Growth Rate |
Total Return Ratio | |
|---|---|---|---|---|
|
IBM |
10.3 |
2.7% |
5.9% |
1.2 |
|
Hewlett-Packard (HPQ -0.14%) |
13.3 |
1.8% |
4.8% |
2 |
|
Microsoft (MSFT -0.84%) |
18.1 |
2.7% |
6.5% |
2 |
|
Accenture (ACN 0.71%) |
19 |
2.5% |
11% |
1.4 |
Peer comparisons courtesy of finviz.com.
From the perspective of a pure value investor -- one who agrees with master investor John Neff that you get your best values from buying companies whose P/E is no greater than the "total return" from a stock's earnings growth and dividend payouts -- IBM stock doesn't look like a great bargain. Its total return ratio is only 1.2, when what we're really looking for is a value of 1 or below.
The upshot for investors
That said, between its par-for-the-course growth rate and strong dividend yield, IBM stock at least gives investors a "total return" better than is available from most similarly sized and focused tech stocks. So while IBM may not be an absolute bargain at today's prices, it does appear to be a relative bargain -- at least, compared to the alternatives.
What's more, consider that IBM, with $13.5 billion in positive free cash flow generated over the last 12 months, is actually a bit more profitable than its P/E ratio suggests. P/E, which counts generally accepted accounting principles earnings, values IBM only on its $12.7 billion in reported "net income." But from the perspective of the real, cash-on-the-barrel profits that IBM is churning out, the company is a better bargain than first meets the eye.
The upshot: While IBM is not a clear-cut, sell the kids and mortgage the house to raise cash bargain, it's not a half bad value in today's market. I think management is making a pretty smart call to be buying back IBM stock now -- and you might want to consider doing the same.
