IBM (IBM) is a Dog of the Dow, there's no doubt about it. Over the last year, only General Electric (GE) and Merck (MRK) have performed worse. With that being said, I think IBM is a bargain and things are looking much brighter for 2018. IBM is still one of the best producers of free cash flow and I don't believe enough credit is given to that. I opened up a position in IBM not too long ago and will continue adding to it. My investment thesis is based on IBM's stock having a significant amount of upside based on the following factors:
- IBM is expecting sales growth in 2018 as a result of its "Strategic Imperatives." Stock performance and valuation multiples indicate the market has not yet bought into these expectations, which I view as an opportunity.
- Large amounts of capital will continue being returned to shareholders. IBM's 3.82% dividend yield is the best out of all mature tech stocks. More importantly, the dividend is well supported with free cash flow and will continue to grow. Additionally, continued share repurchases will support and increase EPS.
- IBM has an attractive fundamental valuation based on multiple approaches. In particular, I calculated 36% upside based on a single-stage discounted cash flow model.
IBM's Financial Snapshot
IBM has had a rough couple of years. Revenue has declined 26% from all-time highs back in 2011, which has put pressure on earnings. In the table below, 2017 net income and EPS include a one-time charge of $5.5 billion associated with the enactment of U.S. tax reform. Full-year operating non-GAAP EPS was $13.80, which shows improvement over last year.
