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Dow 30 Profile: International Business Machines
International Business Machines (IBM - Free IBM Stock Report), a component of the Dow 30, is a worldwide supplier of advanced information processing systems, software, and services. During its over 100-year history, it has both pioneered new information technologies and also sometimes has had to adapt to new technologies and changes in the ways customers used and purchased information technology.
A Long, Distinguished History
Waves of new immigrants in the late 19th century prompted the U.S. Census Bureau to sponsor a contest to find more efficient ways of tabulating census data. The contest was won by Herman Hollerith, who invented the Punch Card Tabulating Machine that tracked data totals by using electric current to sense holes in punched cards. He founded the Tabulating Machine Company in 1896. In 1911, it merged with two other companies to form the Computing-Tabulating-Recording Company, which changed its name to International Business Machines in 1924.
From its early days, IBM, as this tech giant is popularly known, blazed new trails in the realm of corporate management, as well as technology. Under Thomas J. Watson, Sr., who later became IBM’s president, aggressive sales incentives were implemented and efforts to build employee loyalty and spirit were emphasized. The company diversified its workforce early in the 20th Century. It was one of the first companies in the nation to provide employee benefits.
It would be hard to catalog the company’s numerous technological achievements over the years, which track the emergence of the computer industry, but we will mention a few. During World War II, with Harvard University, IBM developed the Automatic Sequence Controlled Calculator (also called the Mark I), the first machine to execute long computations automatically. The machine apparently was 50 feet long and took less than a second to solve addition problems, but much longer for multiplication and division. In 1952, it introduced the first large computer based on a vacuum tube rather than electromechanical switches. Later, transistors replaced vacuum tubes. IBM invented the FORTRAN computer language in 1957. In 1964, the company introduced the System/360, the first large family of computers to use interchangeable software and peripheral equipment. The IBM PC (personal computer) made its debut in the early 1980s, incorporating a processor from Intel (INTC - Free Intel Stock Report) and an operating system from Microsoft (MSFT - Free Microsoft Stock Report).
IBM had to adapt to two technological shifts in the 1980s and 1990s, first with the introduction of PCs and the client/server model (PCs connected to larger server computers), and later with the advent of the Internet and network computing. Both movements changed the way computers were purchased and used. Actions taken in the early 1990s, under IBM’s then-chairman Louis Gerstner, to rebuild the product line, shrink the workforce, and reduce costs helped the company to make the changes.
More recently, following the dot-com crash in 2002, in response to increased commodization in the computer sector (the increasing similarity of previously unique products), IBM made some changes under its CEO, Samuel J. Palmisano. It divested computer hardware product lines like PCs and hard disk drives, and pursued acquisitions in the growing software and services arenas. The product mix shift has supported nine basis points of expansion in IBM’s gross profit margin. Excluding its financing operation, the company’s software and services business lines accounted for 83% of IBM’s revenues and 82% of its profits in 2009, with computer hardware playing a lesser role.
IBM divides its operations into five business groups. Global Technology Services provides outsourcing services to companies. Global Business Services provides consulting and application development/management services. The Software division sells middleware (which facilitates the integration of systems, processes, and applications) and operating system software. The Systems and Technology group sells servers, information storage systems, and point-of-sale retail systems. And Global Financing makes loans and leases available to purchasers of IBM products.
The 2015 Roadmap
IBM has a history of aiming high and surpassing its goals. It beat its 2010 objective of earning $10-$11 a share by one year, in spite of last year’s negative effect of the economic downturn on revenues. The plan now is to earn $20 a share by 2015 and generate $100 billion of cash, 70% of which IBM intends to return to shareholders in the form of stock buybacks or dividends.
The company is focusing on four areas where it believes it can generate $20 billion of revenue between now and 2015. The first is Growth Markets, which includes over 20 developing nations, where an emerging middle class is necessitating improvements in areas like transportation and healthcare. The second, Analytics, involves identifying patterns in data, as in human genomics, security, and marketing. IBM has opened seven analytic services centers around the world. The third area, Next Generation Data Center and Cloud Computing involves helping customers use software and services to adapt to new ways of computing, including providing services over the Internet. The final initiative, which the company calls Smarter Planet, aims to use information technology to solve problems, initially in nine industries, including the automotive, chemicals and petroleum, and medical sectors.
Under the strategic plan, revenue growth (including the contribution from future acquisitions) is expected to add $3.05 to earnings per share by 2015; improvements in productivity and the product mix will add $2.80 to 2015 share net; and stock repurchases will boost earnings by another $2.80 a share by mid- decade.
Although achieving sustained mid-single-digit revenue growth may be difficult, new products, including IBM’s new System z mainframe computer, should help. Some of the above initiatives will entail acquisitions, and IBM envisions spending $20 billion over the next five years for this purpose. Strong finances should support acquisitions and new product development. In late 2010, the company had over $11 billion of cash on its balance sheet, over two-thirds in the U.S. In addition, IBM is not as leveraged as it appears, with all but $5.5 billion of its debt supporting its financing business. (The nonfinancing debt-to-capital ratio was only 22% ).
Even if IBM doesn’t quite reach its ambitious $20-a-share goal by 2015, we think the stock has moderate, well-defined total return potential over the pull to mid-decade, underpinned by about average appreciation in the share price over that span and better-than-average dividend growth. It is also ranked 1 (Highest) for Safety, and is suitable for conservative investors.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.