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Topic: Growth Stocks

International Business Machines Corp. $106 – New York symbol IBM

INTERNATIONAL BUSINESS MACHINES CORP. $106 (New York symbol IBM; Conservative Growth Portfolio, Manufacturing & Industry sector; Shares outstanding: 1.4 billion; Market cap: $148.4 billion; WSSF Rating: Above average) is the world’s largest supplier of computers and information services. It operates in over 170 countries.

IBM has long been a leader in large, mainframe computers for corporations and governments. As well, in the past five years, IBM has expanded its services and software operations through the purchase of over 60 companies for $20 billion. The company is now the world’s second-largest software company after Microsoft Corp.

IBM now gets over 50% of its revenue from services, which include designing and maintaining computer systems for its customers. Services also give IBM steady, long-term revenue streams, which helps cut the risk of these acquisitions.

IBM is also targeting software for future growth. Software now supplies 20% of its revenue, up from 15% five years earlier.

Biggest acquisition to date

For instance, the company is now acquiring Canadian software company Cognos Inc. for $5 billion. This is IBM’s largest acquisition ever.

Cognos’s products help businesses capture and analyze certain data. This helps them make better decisions, and expand profits. Cognos will help IBM compete with other business software companies like SAP and Oracle.

IBM also aims to break the dominance of Microsoft’s Office suite of business programs by giving away its own open-source version. The company hopes this will enhance the appeal of its other software products and systems.

In its hardware operations, IBM continues to focus on higher-margin products such as mainframes and servers. IBM will soon launch a new series of mainframe computers with 50% more storage capacity than its older models. These new computers will also help IBM’s customers cut their energy consumption, and expand profits.

The company is also expanding its computer chip operations. It currently makes the powerful Cell chip, which powers Sony’s PlayStation 3 video game console and some of IBM’s own servers.

Games just the beginning

IBM plans to adapt the Cell chip for other uses. For example, it has teamed up with the Mayo Clinic in Minnesota to develop a new medical imaging system. Such a system would greatly speed up the diagnosis and treatment of cancer and other diseases.

IBM’s revenue rose from $89.1 billion in 2003 to $96.3 billion in 2004. In 2005, IBM sold its personal computer operations for $1.75 billion, and revenue fell to $91.1 billion. Revenue improved to $91.4 billion in 2006, and to $98.8 billion in 2007.

Earnings rose from $4.34 a share (total $7.6 billion) in 2003 to $5.05 a share ($8.6 billion) in 2004. Total earnings in 2005 fell to $8.5 billion, but per-share earnings rose to $5.22 on fewer shares outstanding. Earnings climbed to $6.06 a share ($9.4 billion) in 2006, and to $7.18 a share ($10.4 billion) in 2007.

IBM spent $6.15 billion (6.2% of total revenue) on research in 2007, up slightly from $6.11 billion (6.7% of revenue) in 2006. Accounting rules force it to write off these costs immediately, so it’s more profitable than it appears.

Top patent winner for 15 years

Thanks to this spending, IBM has won more U.S. patents than any other company for the past 15 years. In 2007, it received 3,125 patents. The company’s patent portfolio contributes roughly $1 billion to annual revenue.

IBM continues to win new customers in overseas markets. International customers now provide 60% of its revenue.

The expansion of banking, e-commerce and other industries in counties like China, India, Russia and Brazil should spur strong revenue growth for IBM in the next few years. The company’s broad geographic base also helps insulate it from a possible economic slowdown in the U.S.

IBM’s balance sheet is strong, so it can easily continue to invest in research and make acquisitions. Long-term debt of $19.5 billion is roughly equal to its annual cash flow. IBM has $16.1 billion ($11.58 a share) in cash.

The company spent $18.8 billion on share buybacks in 2007. It now aims to repurchase a further $1 billion worth of its stock by the end of February 2008. That would leave it with $700 million under its current repurchase authorization.

Low p/e adds to its appeal

IBM should earn $8.00 a share in 2008, and the stock trades at just 13.3 times that figure. It also trades at 1.5 times its revenue of $69.42 a share. That’s cheap in light of IBM’s well-known brand, worldwide reputation, high research spending and aggressive share repurchases. The $1.60 dividend yields 1.5%.

IBM is a buy.

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