IBM: Watson and a Shift to Analytics

05/20/2015 8:00 am EST

Focus: STOCKS

Patrick McKeough

Editor, Successful Investor

This leading technology company has seen its shares fall due to the fact that many businesses are shifting to cheaper cloud computing platforms and spending less on IBM’s mainframes and consulting services, says Pat McKeough, editor of TSI Network.

International Business Machines (IBM) has fallen from $190 in October 2014. But the company has a long history of shifting from unprofitable businesses to fast-growing ones.

And we feel its new plan to focus on cloud computing and analytics software will spur its earnings for years to come. To top it off, IBM’s strong balance sheet gives it lots of room to keep buying back shares and raising its dividend.

In the past few years, IBM has moved away from making computers to designing entire systems and managing them for businesses and government agencies. It provides these services under long-term contracts, which gives it predictable revenue streams. In 2014, computer services supplied 59% of the company’s revenue.

A big part of IBM’s growth will come from analytics software, which can process huge amounts of data. That helps the company’s business clients boost their efficiency. In the past five years, IBM has spent $17 billion buying over 30 smaller analytics firms.

Perhaps the best-known part of IBM’s analytics business is its Watson supercomputer, which beat human contestants on Jeopardy. The company now plans to invest $1 billion to create analytics programs that can take advantage of Watson’s computing power.

IBM also recently set up a business to develop software that analyzes data from smartphones, tablets, vehicles, and appliances. The trend toward adding products beyond computers and mobile devices to the Web is called the Internet of Things and it could total over 30 billion connections by 2020.

Meanwhile, IBM continues to build up its cloud computing operations. Unlike competing platforms, IBM Cloud offers a combination of secure local data storage and the convenience of cloud-based programs.

In all, IBM plans to spend $4 billion on analytics and the cloud in 2015. It expects revenue from these businesses to rise to $40 billion by 2018 and account for 40% of its total, up from 27% in 2014.

IBM won 7,534 US patents in 2014, up 10.6% from 6,809 in 2013. This was also the 22nd consecutive year IBM received more patents than any other firm and the most ever awarded to one company in a single year.

IBM’s strong balance sheet will support its transformation. IBM expects to earn $15.75 to $16.50 a share this year and it trades at just 10.2 times the midpoint of that range. The $4.40 dividend yields 2.7%.

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