Top Pick in 2016: Legacy Tech Company: IBM

01/11/2016 7:00 am EST

Focus: STOCKS

Matthew Castel

Head of Strategy, Logos LP

Often viewed as a legacy technology company, our Top Pick for conservative investors is firmly in transition, moving away from hardware (only 6% of sales today) towards providing services and solutions, explains Matthew Castel, money manager and value investor with Logos LP.

Although a well publicized option since Warren Buffett’s move into the name, the conservative—or income oriented—long-term investor should consider International Business Machines (IBM) in 2016.

Its goal isn’t to compete with companies like Amazon (AMZN), Microsoft (MSFT), and Apple (AAPL) but to partner with its enterprise customers to provide the best solutions regardless of their origination. 

This transition to sophisticated services focusing on solving business problems through integrated solutions is a high growth area that will allow IBM to turn the page on 14 straight quarters of lower sales.

Furthermore, both IBM’s gross and operating margins have been expanding consistently and are greater than most companies in the global information technology services industry. 

Return on equity and return on assets have been growing consistently well above the industry median with return on invested capital far outpacing the weighted average cost of capital.

Free cash flow as a percentage of sales has also been consistent with a price to free cash flow ratio well above the industry average.

In addition, the company has shown an unwavering commitment to its dividend payouts which have been going strong for almost a century.

In fact, IBM has never missed a dividend payment since its inception in 1916, with dividend payments steadily increasing for the past two decades.

Its dividend payout ratio ranks in the top 2% of companies in the global information technology services industry as well as its share buyback rate.

From a valuation perspective, free cash flow suggests a fair value of around $190, indicating upside of about 35% from currently depressed price levels.

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