Summary
- It's rare to see a quality dividend-paying stock trading around the 10.0 to 11.0 P/E mark today.
- IBM's low P/E ratio likely reflects the effect of declining earnings over the last five years. Analyst EPS estimates suggest a resurgence ahead.
- Not sure what price to pay?
- This idea was discussed in more depth with members of my private investing community, Analysts Cnr | H2 SuperGrid. Get started today »
International Business Machines: Investment Thesis
Background
International Business Machines (IBM) is currently trading at an adjusted non-GAAP P/E ratio of 10.30. To gain perspective, Microsoft (MSFT), Intel (INTC), and Cisco (CSCO) are currently trading at adjusted non-GAAP P/E ratios of 28.87, 10.93, and 15.46, respectively. IBM's low P/E ratio likely reflects the effect of earnings decline over the last five years. There's an expectation of earnings growth going forward due to a combination of the acquisition of Red Hat and opportunities to grow cloud-related businesses. But there may still be a couple of quarters of earnings decline compared to prior year quarters.
Is IBM A Buy?
It's rare to see a quality dividend-paying stock trading around the 10.0 to 11.0 P/E mark today. Whether IBM is a buy at present depends on future success with exploiting the Red Hat acquisition and growth in the cloud puts a halt to earnings decline, and actually delivers earnings gains.
Two choices - Wait For a Lower Share Price Or Wait For Q3 And Q4 Results To Better Judge Progress
Based on current share price of $141.28, and on analysts' consensus estimates, and assuming a P/E ratio around its five-year historical median of 10.62, IBM is indicated to provide returns in the order of 5.6% through end of 2020, climbing to ~11% if held through the end of FY 2022. Share price movements over the past three months suggest holding off buying could provide an opportunity to buy well below the current share price. Doing so would significantly lift potential returns and provide a margin of safety. Stress testing suggests even if the share price remained flat at the current level over the next four years, an increasing dividend could result in average yearly rates of return in excess of 4% if shares bought now were held through end of 2022. At that level of return, IBM could be seen as an alternative to holding cash or Treasuries in the event of a market downturn. At the same time, if analyst consensus estimates are met, there's considerable upside potential, and mid-teens returns, if the wider market does not suffer a lasting setback impacting all stocks.
