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Topic: Blue Chip Stocks

INTERNATIONAL BUSINESS MACHINES CORP. $153

INTERNATIONAL BUSINESS MACHINES CORP. $153 (New York symbol IBM, Conservative Growth Portfolio, Manufacturing & Industry sector; Shares outstanding: 960.0 million; Market cap: $146.9 billion; Price-to-sales ratio: 1.8; Dividend yield: 3.7%; TSINetwork Rating: Above Average; www.ibm.com) began operating in 1911, and is now one of the world’s largest computer companies with operations in over 175 countries.

IBM has four main divisions: Technology Services and Cloud Platforms (45% of its revenue); Global Business Services, developing and managing computer systems (22%); Cognitive Solutions, including analytics software (22%); and Systems, mainly large mainframe computers (9%). The remaining 2% of its revenue comes from IBM’s financing division, which lends to the company’s clients.

In the past few years, IBM has cut some of its slower-growing businesses. These include the low-end server business it sold to China’s Lenovo Group for $2.1 billion in cash and Lenovo shares.

The company also sold its computer chip operations — a money-losing business— to Globalfoundries Inc. This operation accounted for just 2% of IBM’s revenue. As part of the deal, IBM agreed to buy chips from this company for the next 10 years.

Partly due to these asset sales, the company’s revenue fell 22.2%, from $105.1 billion in 2011 to $81.7 billion in 2015. The higher U.S. dollar also hurt the contribution of its overseas operations, which supply over 60% of its total revenue. In 2015, unfavourable exchange rates cut revenue by $7 billion.

Despite the sales drop, IBM’s earnings rose 10.8%, from $16.6 billion in 2011 to $18.4 billion in 2013. The company is an aggressive buyer of its own shares. As a result, per-share earnings gained 21.9%, from $13.65 to $16.64. However, earnings then fell to $16.53 a share (or a total of $16.7 billion) in 2014, and to $14.92 a share (or $14.7 billion) in 2015.

‘Strategic’investment pays off

The company’s shift to cloud computing and software— what it calls “Strategic Imperatives”— is helping to offset slower sales of mainframe computers and related services.

Revenue from those new operations totalled $29.8 billion in the 12 months ended March 31, 2016. That’s equal to 37% of IBM’s total revenue, up from 22% in 2013.

The company’s overall revenue in the quarter ended March 31, 2016, declined 4.6%, to $18.7 billion from $19.6 billion a year earlier. Earnings fell 21.5%, to $2.3 billion from $2.9 billion. Per-share profits dropped 19.2%, to $2.35 from $2.91, on fewer shares outstanding.

IBM’s Strategic Imperatives are key to improving its long-term earnings. Since 2010, the company has spent $30 billion buying smaller firms that operate in related fields.

Another big part of IBM’s future growth should come from its Watson supercomputer technology.

That computer is best known for competing against contestants on the Jeopardy quiz show. But now it is analyzing huge amounts of data collected from webconnected devices. Called the “Internet of Things,” this network could connect 30 billion machines by 2020.

For example, Japanese automaker Subaru is now using Watson to develop self-driving cars. IBM will also store this testing data on its cloud-based systems. That will let Subaru engineers easily search for specific data, such as images from car-mounted cameras and road conditions. In the future, IBM will likely license this system to other automakers.

Research also plays a big role

In addition to acquisitions, the company enhances its expertise with heavy spending on research. In the latest quarter, those costs rose 12.3%, to $1.5 billion (or 7.8% of its revenue) from $1.3 billion (or 6.6% of revenue) a year earlier.

This strong commitment to research helped IBM win approval for 7,355 U.S. patents in 2015. This was the 23rd consecutive year the company received more patents than any other firm. Licensing out its intellectual property generated $682 million for IBM in 2015.

The company’s strong balance sheet will help it complete its transformation. Its long-term debt of $40.3 billion (as of March 31, 2016) is a moderate 27% of its market cap. At the same time, IBM also held cash and investments of $14.9 billion, or $15.49 a share.

The company generated $14.3 billion in free cash flow (cash flow less capital expenditures) in the past 12 months. That gives IBM lots of room to keep buying back its shares: it still has $4.7 billion left in its current budget for repurchases.

21 years of rising dividends

The company also recently raised its quarterly dividend by 7.7%, to $1.40 a share from $1.30. The new annual rate of $5.60 yields 3.7%. IBM has paid dividends continuously since 1916, and has increased the annual rate each year for the past 21 years.

The company expects to earn at least $13.50 a share this year. The stock trades at just 11.3 times that forecast.

IBM is a buy.

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