Both IBM (NYSE:IBM) and Hewlett-Packard (NYSE:HPQ) are a part of old tech, with histories spanning multiple generations. Hewlett-Packard was founded in the depths of the Great Depression, bringing a sound-testing device to market in 1938. IBM, formerly the Computing Tabulating Recording Co., traces its roots back 60 years earlier, before the turn of the 20th century.
Moving forward, you'll find two companies facing difficulties in this new tech paradigm. IBM reported lower revenue last fiscal year than in 2008, the height of the Great Recession. Hewlett-Packard also reported higher revenue in 2008 than it did last year. The two CEOs have taken different approaches to shareholder returns going forward, and investors need to ask which CEO has the better plan: IBM's Ginny Rometty or HP's Meg Whitman.
IBM's high-margin focus combined with an aggressive share repurchase program
First of all, it's pretty safe to assume that IBM's revenue growth will be hampered going forward as well. The issue isn't one of operations, but rather one of choice. Recently, IBM has been on a divestiture spree. It sold its x86 server business to Lenovo earlier this year and it announced that it was selling its chip business to Globalfoundries when reporting disappointing earnings earlier this week.
In turn, IBM seeks to return value to shareholders through a combination of its generous capital return policy and a focus on higher-margin businesses. In an interview today, Rometty acknowledged IBM's poor performance but said the company is reinventing itself by focusing on data analysis and cloud computing. "The strategy is correct," she said. "Now it's our speed of execution that needs to improve."
One area where speed isn't a concern is IBM's capital return policy. The following chart will give you the proper context about IBM's cash moves over the past five full fiscal years:
The company has engaged in a rather aggressive capital return policy. Since 2009, it has given back over $80 billion to shareholders, with $64 billion coming from share repurchases. The end result is a company that has reduced its shares outstanding by nearly 18%. And after the drop, IBM is valued at a price-to-earnings ratio of 10 and a dividend yield of 2.4%
Hewlett-Packard goes a different route
Hewlett-Packard has also engaged in buying back its stock, although not at the same scale as IBM. However, going forward, the company is looking to split the company's consumer-facing business into a company called HP and a business-oriented company named Hewlett-Packard Enterprises. The company expects that a spinoff will let each business be more nimble and will allow for the divestiture to "unlock value" (read: command higher valuation multiples). Right now, the company trades at a price-to-earnings multiple of 13 and a dividend yield of 2%.
And it is possible, but these two sections face different threats: Hewlett-Packard's consumer-facing business is facing struggles in both its PC and printer businesses. And while a good part of that is weak hardware markets overall as PCs are being disrupted by tablets, HP is strongly affected by this trend. In Enterprise, Hewlett-Packard finds a better growth story in terms of macroeconomics, but intense competition from IBM, Dell, EMC, Microsoft, and Amazon.com.
While both companies seek to adjust to the new tech world, I think IBM is the stronger play. First, I think the argument about unlocking value isn't a strong one for long-term investors. Although spinoffs tend to outperform for the first three years after the divestiture, long-term fundamental investors need to consider intentions. Does the split improve the company fundamentally, or is a CEO reaching to compensate for lack of growth and no clear path forward operationally?
Sadly, I think the latter is the case with HP. While Whitman has spoken ad nauseum of HP's turnaround, it still hasn't materialized yet. So right now, IBM is a higher-yielding investment that's cheaper on a price-to-earnings ratio after its post-earnings drop, with a plan to enrich shareholders.
IBM's plan appears to be buying back shares and growing its margins, rather than revenue, to add value for shareholders. And while the company disappointed some shareholders by reneging on its wildly ambitious $20 EPS target by 2015, the company still lowered its shares outstanding by 18% in five years. In short, I like IBM's shot in the high-margin cloud space and enterprise moves with Apple more than I like Hewlett-Packard's enterprise and consumer chances.
Jamal Carnette has no position in any stocks mentioned. The Motley Fool recommends Amazon.com and Apple and owns shares of Amazon.com, Apple, EMC, IBM, and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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