Tech giants Intel (INTC -2.86%) and IBM (IBM -0.05%) have had a miserable year. Intel slashed its full-year revenue forecast by nearly $1 billion earlier this year due to weak demand for new PCs. IBM recently posted its 13th consecutive quarter of sales declines, due to sluggish demand for its IT services, the divestment of low-margin businesses, and a strong dollar. As a result, both stocks have fallen around 20% since the beginning of the year.
But as fearful investors dump both stocks, it might be time for contrarian ones to scoop up some shares. Let's compare these two beaten-up blue chips and see which is a better buy at current prices.
Which is fundamentally cheaper?
Intel currently trades at 12 times trailing earnings, compared to an average P/E of 19.5 for the broad line semiconductor industry. IBM has a P/E of 13, which is lower than the average P/E of 20 for the IT services industry. Both stocks trade at a discount to the S&P 500's average P/E of 20.
Intel looks "cheaper" than IBM based on trailing earnings, but Big Blue is cheaper based on forward estimates. Intel trades at 12 times forward earnings, compared to IBM's forward P/E of 9. Analysts expect Intel's earnings per share to slip 7% in fiscal 2015 but recover 8% the following year. IBM's earnings are expected to follow a similar trajectory, dropping 5% this year before bouncing back 2.5% in fiscal 2016.
A stock's 5-year PEG ratio tells us how "cheap" a stock is in relation to its long-term earnings growth potential. Based on Thomson Reuters estimates, IBM's 5-year PEG ratio of 1.45 is lower than Intel's ratio of 1.6, making it slightly cheaper based on long-term forecasts.
Which uses its cash more efficiently?
Investors should also check how both companies spend their free cash flow (FCF). Over the past 12 months, Intel spent 41% of its FCF on dividends and 82% on stock buybacks. That might seem unsustainable, but Intel only spent $1.5 billion on buybacks in the first half of fiscal 2015 versus $10.8 billion on buybacks last year. Since Intel's stock has slipped over 20% since the beginning of the year, it actually overpaid for its own shares last year. Intel also has a rocky history of dividend increases -- it suspended dividend hikes from 2012 to the end of 2014, but still pays a decent forward annual yield of 3.4%.
IBM spent 34% of its FCF on dividends and 27% on buybacks over the past 12 months. IBM has steadily reduced its buybacks over the past year to curb its dependence on buybacks to inflate earnings per share. IBM has also raised its dividend for 15 consecutive years and pays a forward annual dividend yield of 3.2%, making it a fairly dependable stock for income investors.
IBM's more disciplined use of its cash flow, its gradual reduction of buybacks, and its stable history of increasing dividends makes it seem wiser than Intel, which hikes its dividends at unreliable intervals while buying back too much stock at high prices.
Plans for the future
Both Intel and IBM are expanding into new markets to offset stagnation in their core businesses. Intel has been buying its way into the mobile market by subsidizing OEMs with steep discounts on chips, co-marketing agreements, and financial assistance in redesigning logic boards. That caused its mobile unit to post an operating loss of $4.2 billion last year -- down from a loss of $3.1 billion in 2013.
Intel's Internet of Things (IoT) business -- which makes tiny modules for everyday objects and wearables -- is small but steadily growing. Last quarter, the division's revenue rose 4% annually to $559 million and accounted for 4% of Intel's top line. Intel's acquisition of Altera (NASDAQ: ALTR), which makes programmable chips for various industries, could bolster that growth.
IBM relies on five "strategic imperatives" -- the cloud, data analytics, mobile, social, and security businesses -- to diversify its top line away from IT services. In 2014, revenue from those businesses climbed 16% annually and accounted for 27% of IBM's top line. It expects those businesses to generate $40 billion in revenues by fiscal 2018 and account for 44% of its forecast revenue. To aid this transition, IBM is divesting slower growth businesses while buying higher growth ones like cloud computing giant SoftLayer.
The better buy: IBM
IBM is a better buy than Intel in my book, thanks to its cheaper fundamentals, more efficient use of its free cash flow, and clearer plans to transition away from its core IT business. Intel's plans for the future are murkier -- it's unclear if its billions in mobile subsidies will ever pay off, while its IoT business remains a tiny sliver of its top and bottom lines.