First founded in 1911, IBM is one of the oldest tech companies in the world. To be able to survive the market landscape that long in an ever changing lightning fast industry, it had to adapt its business model quickly and frequently. At the moment, it is turning away from its core business model and focusing its future more on cloud computing, AI, and subscription services.
Following a six year period of sales declines, IBM is finally returning to growth, however, its valuation is super cheap, while its dividend yield is at a 24 year high. There are six key things investors need to know in order to determine whether IBM is a great deep value lead opportunity, or a value snare that you should steer clear from.
When it comes to dividend growth retirement portfolios, I often feel its a good bet to buy out of favor high-yield stocks. I always feel this is the right move if i am of the impression that the companies long-term future is favorable, and the market is in a state of over pessimism. I don’t even let years of poor returns sway my decision, as long as the basic fundamentals remain secure and are moving in a good direction.
However, when I’m faced with flailing blue-chips, such as IBM, things become less clear cut to me. It seems this tech giant is in one of its corporate shifts , which its managed to do many times over its 107 year history in order to stay alive and relevant.
The company has experienced 6 years in a row of yearly sales declines and three years of declining profits. The only thing keeping the company afloat over the past five years has been its free cash flow.
However, its forward yield is now trading at its highest level in over 24 years, so now is the time to take a close look at IBM’s perplexing past, along with its promising yet uncertain future. Here are 6 things to help investors determine whether IBM is a value trap, or a potential deep value high yield investment.
- We must remember IBM is a tech giant of legendary status in the middle of yet another change in business direction. Currently IBM is the go to provider for 92 of the worlds largest 100 banks, 10 out of 10 of the worlds largest insurers, 8 out of 10 of the worlds largest airlines and 9 of the worlds largest retailers. Also, its Zline mainframe computers are processing over 30 billion business transactions a day. It’s IT services have and remain to be the backbone of the corporate worlds departments across the globe. IBM’s gross IT business has generated gross margins of 55 to 60% which is above the industry average of 47%. Also, 80% of IBM’s revenue is cross platform, which means when i client purchases IBM they most often buy more then one service at a time. It remains an incredibly relevant and go to IT provider for most of its customers.
- IBM’s future Tech focused strategy shows a good business model potential for a company that is looking towards the future. The company has a strong R&D history which has enabled it to innovate and adapt to over 100 years of technological changes. They are also currently investing in quantum computing and blockchain technology, though these new developments have not yet been fully integrated into most of their SI platforms. They also have another department that is dependable and much needed in today’s insecure world, cyber-security. In a world that is become more digitized every single day, the threat of hacks and need of security have helped to drive 60% year over year growth for the company’s security business.
- There are 3 major problems that IBM needs to address and overcome in the coming years in order to remain successful. The first issue is while SI is growing at double digits, that growth is also being offset by setbacks and declines in the legacy business. The cause of this is the larger number of corporate IT clients who are abandoning mainframes and physical servers for more secure outsourced cloud based solutions. A good example of this is even though IBM is experiencing extraordinary growth in SI revenue, the company’s business segments are still failing to generate any sales growth at all.
- There is also the concern that questionable management quality is one of the reasons the company is hurting right now. We all know how paramount good management is in order to have a successful company. Rivals are always trying to disrupt your business and steal away your market shares, which means it takes strong management to be able to adapt to ever changing and challenging industry conditions. Without good management you won’t be able to bring in good returns on capital, strong profitability and ultimately, growing dividends. However, it is important for investors to know that over the last three years, $10 billion of IBM’s investment spending has been on the acquisition of 34 companies. IBM feels these small add-ons can grow and improve its cloud offerings, however, M&A is a difficult thing. And it has been pointed out before that IBM’s cloud based purchases have been poorly integrated in a haphazard fashion. (Source: Seeking Alpha, “This Blue-Chip’s Dividend Yield is At a 24 Year High: 6 Things investors Need to Know”)
- Lets address IBM’s earnings and free cash flow. If we were to expect that IBM’s earnings and free cash flow will continue to fall for a ridiculously long period of time, this is an overly pessimistic view to harbor. However, IBM has also been known for over-promising and under-delivering in the past on guidance. Just look at its 2015 prediction that it would get up to $20 per share in adjusted EPS, a goal that was missed by a mile. So its not unprecedented that the company will continue to underwhelm on the downside. However, overall i think its good to be a cautious optimist about the company’s dividend growth potential. If management is able to deliver on guidance, the company will in turn achieve strong dividend growth, along with market crushing returns around 12% or more. However, if they continue to struggle with executing their vision, they could also end up under-performing delivering historically weaker returns of around 8% per year. Therefore, it still remains to be seen if IBM is a value trap or not, however, the stocks rock bottom valuation, I feel, provides investors with a high enough safety net margin.
- Lastly, as just stated above, rock bottom valuation provides a good margin of safety for investors. IBM has under-performed in the market for the past four years, and have also continued to disappoint in the last 12 month period. However, this makes for an attractive deep value opportunity, for those that have faith in the long term turnaround plan.