IBM: Big Blue Is Still a Buy

10/16/2019 5:00 am EST

Focus: TECHNOLOGY

Ben Reynolds

CEO, Sure Dividends

IBM (IBM) is a large multinational information technology company founded more than 100 years ago with $80 billion in 2018 revenue and a market cap of around $125 billion, notes Ben Reynolds, editor of Sure Retirement.

On July 9th IBM announced it closed on its $34 billion acquisition of Red Hat Inc. Red Hat generates annual revenue of about $3 billion and operates in the open-source software market, primarily distributing technology products used in data centers. IBM made the deal to boost its cloud platform and expects the acquisition will be accretive to earnings within 12 months of closing.

IBM is investing heavily for growth and is finally seeing a return on its investment. IBM’s strategic initiatives (including cloud, open source, analytics, and data) will generate the company’s future growth. For example, total cloud revenue increased 8% to $19.5 billion over the past 12 months. Red Hat will further expand the company’s cloud infrastructure.

We expect 3% annual earnings growth through 2024. IBM received the most patents of any U.S. company in 2018, for the 26th year in a row. IBM received 9,100 patents across artificial intelligence, cloud computing, and cybersecurity, which are its most promising growth areas.

IBM ranks highly in terms of dividend safety. The company is projected to have a dividend payout of 50% for 2019, which leaves plenty of room for annual dividend increases moving forward.

Moreover, IBM’s interest coverage ratio has consistently exceeded 20x over the last decade. IBM’s credit rating was cut at S&P Global after the Red Hat acquisition on debt concerns, but the company still maintains a strong rating of ‘A.’ IBM had $12.2 billion of cash at the end of the most recent quarter.

Based on expected earnings-per-share of $13.90 for 2019, IBM stock holds a price-to-earnings ratio of 10.2. Our fair value estimate for IBM is a price-to-earnings ratio of 12.0, a slight discount to its average price-to-earnings ratio over the past 10 years.

If its stock valuation increases to our fair value estimate, the corresponding multiple expansion would generate annual returns of 3.3% if it occurs over the next 5-year period. In addition, 3% expected annual earnings growth and the 4.6% dividend yield bring total expected returns to 10.9% per year over the next five years.

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