IBM: Despite Flat Sales, a Profitable, Dividend-Paying Money Machine

With International Business Machines Corp. (IBM) having gained momentum and trading at its all-time high, we take the opportunity to analyze the company, in order to determine where the value of the stock could be in 10 years. IBM's business model is to help clients succeed in delivering business value by becoming more innovative, efficient and competitive through the use of business insight and IT solutions; and, provide long-term value to shareholders. The Company's global capabilities include services, software, hardware, fundamental research and related financing. The broad mix of businesses and capabilities are combined to provide business insight and solutions for the Company's clients. The major operations of the Company are comprised of: a Global Technology Services segment; a Global Business Services segment; a Software segment; a System and Technology segment; and a Global Financing segment. Here is the 2009 IBM’s sales proportion by segment. Segment 2009 Global Technology Services 39.00% Global Business Services 18.44% Software 22.34% Systems and Technology 16.91% Global Financing 2.40% Other 0.91% At $146.92, IBM is trading at $0.01 from its all-time high of $146.93 reached on November 5, 2010. IBM is a stock that is less volatile than the market. The volatility of IBM is measured by its beta ratio of 0.74, which signifies that the stock has a theoretical volatility 26% lower than the market. We compared the return of IBM with the market (SPY) from the years 1994 to 2010 YTD (As of November 5). All paid dividends are included in the returns. Civil year International Business Machines Corp. ((IBM)) Market ((SPY)) 1994 31.86% 0.33% 1995 25.67% 37.71% 1996 67.23% 22.35% 1997 39.14% 33.35% 1998 77.06% 28.49% 1999 17.52% 20.32% 2000 -20.73% -9.70% 2001 42.95% -11.78% 2002 -35.44% -21.54% 2003 20.40% 27.88% 2004 7.12% 10.54% 2005 -15.82% 4.70% 2006 19.53% 15.61% 2007 12.82% 5.16% 2008 -20.39% -36.38% 2009 58.09% 26.05% 2010 (As of November 5) 13.65% 12.10% Over the 17 periods observed, IBM outperformed the market 10 times. An investment made in IBM on December 31, 1993 had a spectacular return of 1,041.89% on November 5, 2010, while an investment in the market ((SPY)) for that same period had a return of 228.93%. However, the major part of the return of the stock has been made in the ‘90s because if we look at the last decade, an investment made in IBM on December 31, 1999 had a return of 47.57% on November 5, 2010, while an investment in the market for that same period, had a return of -1.19%. All the paid dividends are included in these returns. In the more recent past, since 2006, IBM outperformed the market each year and 2010 YTD. Let’s have a look at the past EPS, dividend per share and payout ratio of IBM in the first table and at the dividend growth in the second one. (All amounts are split adjusted for the 2-for-1 stock splits of May 27, 1999 and May 28, 1997). Year Diluted EPS Dividend per share Payout Ratio 1991 $(1.25) $1.21 N/A 1992 $(2.18) $1.21 N/A 1993 $(3.56) $0.395 N/A 1994 $1.26 $0.25 19.84% 1995 $1.77 $0.25 14.12% 1996 $2.51 $0.325 12.95% 1997 $3.00 $0.3875 12.92% 1998 $3.29 $0.43 13.07% 1999 $4.12 $0.47 11.41% 2000 $4.44 $0.51 11.49% 2001 $4.35 $0.55 12.64% 2002 $2.06 $0.59 28.64% 2003 $4.32 $0.63 14.58% 2004 $4.93 $0.70 14.20% 2005 $4.88 $0.78 15.98% 2006 $6.11 $1.10 18.00% 2007 $7.18 $1.50 20.89% 2008 $8.93 $1.90 21.28% 2009 $10.01 $2.15 21.48% 2010 $11.40 (Estimated) $2.50 21.84% TTM Civil Year Dividend Growth 1991 to 1992 0.00% 1992 to 1993 -67.36% 1993 to 1994 -36.71% 1994 to 1995 0.00% 1995 to 1996 30.00% 1996 to 1997 19.23% 1997 to 1998 10.97% 1998 to 1999 9.30% 1999 to 2000 8.51% 2000 to 2001 7.84% 2001 to 2002 7.27% 2002 to 2003 6.78% 2003 to 2004 11.11% 2004 to 2005 11.43% 2005 to 2006 41.03% 2006 to 2007 36.36% 2007 to 2008 26.67% 2008 to 2009 13.16% 2009 to 2010 16.28% The 2010 estimated EPS of $11.40 reflects the company’s minimum expectations for the full year. From 1994 to 2010 (2010 estimated), the compound annual growth rate was 14.76% for the company’s EPS, which is excellent. From 1995 to 2010, the company increased its dividend at a compound annual growth rate of 16.58%, which is more than excellent. If we take 1995 as a starting year, the company increased its dividend each year since 1995. Since that year, the minimum year over year dividend increase has been 6.78% and the 7 last year over year dividend increases have been in the two-digits. IBM is a powerful dividend payer. The average payout ratio for the years 1994 to 2010 (2010 TTM) has been 16.78%. Overall, the payout ratio of IBM remains low. With an annual dividend of $2.60, a TTM EPS of $11.00, a TTM payout ratio of 21.84%, the company has flexibility to increase the dividend and this one is more than safe. The current yield of IBM is 1.77% while the current yield of the market ((SPY)) is 1.80%. As investors, it’s important to select companies with rising dividends and rising EPS to profit from a rising share price. Moreover, it’s important to select companies that increase their sales year over year. Buybacks of shares are also important to boost future EPS. Quarter after quarter, shareholders of a company that repurchased its shares become less and less diluted. Here are IBM’s sales by year from 1991 to 2010 (2010 TTM). You will also find the weighted average shares outstanding - diluted, the sales / share and the price/share (P/S) ratios for the years 1991-2010 (2010 TTM). Year Sales Weighted average shares outstanding - diluted Sales/Share P/S 1991 $64,766,000,000 2,288,013,528 $28.31 0.79 1992 $64,523,000,000 2,283,585,956 $28.26 0.45 1993 $62,716,000,000 2,292,956,960 $27.35 0.52 1994 $64,052,000,000 2,387,929,436 $26.82 0.69 1995 $71,940,000,000 2,335,593,064 $30.80 0.74 1996 $75,947,000,000 2,159,417,808 $35.17 1.08 1997 $78,508,000,000 2,021,869,884 $38.83 1.35 1998 $81,667,000,000 1,920,130,470 $42.53 2.17 1999 $87,548,000,000 1,871,073,912 $46.79 2.31 2000 $88,396,000,000 1,812,118,000 $48.78 1.74 2001 $85,866,000,000 1,771,230,000 $48.48 2.50 2002 $81,186,000,000 1,730,941,000 $46.90 1.65 2003 $89,131,000,000 1,756,090,000 $50.76 1.83 2004 $96,293,000,000 1,708,872,000 $56.35 1.75 2005 $91,134,000,000 1,627,632,000 $55.99 1.47 2006 $91,424,000,000 1,553,535,000 $58.85 1.65 2007 $98,786,000,000 1,423,039,000 $69.42 1.56 2008 $101,048,000,000 1,381,773,000 $73.13 1.15 2009 $95,758,000,000 1,341,352,000 $71.39 1.83 2010 (TTM) $97,538,000,000 1,272,800,000 (Latest indicated) $76.63 1.92 The compound annual growth rate of the sales of IBM has been 2.30% for the period of 1991-2009. This is overall a low growth rate, and this is why IBM is considered a company with “flat sales”. If we look at the weighted average shares outstanding - diluted of the company, we can see a very encouraging point: the company repurchased its shares over time. We can clearly see a downtrend of the company’s outstanding shares from the years 1991-2010. Today the company has 1,015,213,528 less outstanding shares than in 1991, meaning an average buyback of shares of 53,432,291 per year over the period. The trend is clearly downwards over time and linear. The average price/sales (P/S) ratio is 1.46 for the period 1991-2010 (2010 TTM). For the last 11 years (2000-2010 TTM), the average P/S ratio is 1.73. Over the last 11 years, this ratio remains generally constant around the average with a few exceptions. IBM has long been-- and remains more than ever-- a global company. In 2009, 42.99% of the company’s sales came from the Americas, 34.86% from Europe, Middle East and Africa, and 22.16% from Asia Pacific. If we analyze the sales since 2002, we can clearly see that the proportion of the sales of IBM coming from different geographic area remains stable. As a global company, IBM will profit from the growing emerging markets. Here, you will find a table of IBM’s sales by geographic area. (OEM not included (2002-2005)) Geographic Area 2009 2005 2002 Americas 42.99% 44.18% 46.79% Europe/Middle East/Africa 34.86% 34.63% 31.17% Asia Pacific 22.16% 21.19% 22.04% Let’s have a look at the historic P/E and historic forward P/E of IBM. Year P/E at year-end Forward P/E at year-end 1993 N/A 11.21 1994 14.58 10.38 1995 12.91 9.10 1996 15.09 12.63 1997 17.44 15.90 1998 28.02 22.38 1999 26.18 24.30 2000 19.14 19.54 2001 27.81 58.72 2002 37.62 17.94 2003 21.45 18.80 2004 20.00 20.20 2005 16.84 13.45 2006 15.90 13.53 2007 15.06 12.11 2008 9.42 8.41 2009 13.08 11.48 2010 13.36 TTM 11.68 The current TTM P/E of IBM is 13.36. For the period 1994-2010 YTD, we have 17 periods of P/E with an average of 19.05. We can clearly see over the period that the P/E of IBM was not at all constant around the average and the trend has been downwards from 1998 to 2008. Since 2006, the P/E is constant in a range of 13 to 16, except in 2008 during the crisis. The actual valuation of the stock with a P/E of 13.36 is in the bottom of that current range. For the forward P/E of IBM for the period 1993-2010 YTD, we have 18 periods of forward P/E with an average of 17.32. Over the period, the forward P/E was also not at all constant around the average and the trend has been downwards from 1999 to 2008. Since 2005, the forward P/E is constant in a range of 11.50 to 13.50, except in 2008 during the crisis. Here also, the actual valuation of the stock with a forward P/E of 11.68 is in the bottom of that current range. The actual forward P/E of 11.68 is obtained by the average analyst estimates for the full fiscal year 2011 EPS of $12.58 for IBM. Here are the company’s balance sheets for the fiscal year 1992, 1995, 2000, 2005 and 2010 MRQ (September 30). We have also included the sales, the net income and the market capitalization at year-end.click to enlarge Over that long period, IBM has been a strong wealth creator for its shareholders. We can see this by the increase of the market capitalization of the company. From $28.76B in 1992, the market capitalization reached $182.53B on November 5, 2010. The company increased its value by constantly increasing its assets, liabilities, sales and net income over time. The stockholders’ equity of IBM has remained constant for the period 1992-2010. Despite the constant shareholders’ equity which is book value, it is clear that IBM shareholders became wealthier with the rising net income of the company, which pushed up the market capitalization of the company with a rising share price, and that produced an excellent return over the period. For the measure of profitability, IBM has a TTM profit margin of 14.67%. The TTM operating margin is 17.60%. For the measure of the financial strength, the MRQ current ratio is 1.25 for IBM. The company has a MRQ debt/equity ratio of 1.23. For the measure of management effectiveness, IBM has a TTM ROA of 13.55% and a TTM ROE of 65.43%. A better way to predict the future is to look at the past; this is why we analyzed the past of IBM. Now, we will use the past to extrapolate what could be the return in 10 years of an investment made in IBM today. We previously saw that from 1994 to 2010 (2010 estimated), the compound annual growth rate has been 14.76% for the company’s EPS. The compound annual growth rate for the company’s dividend has been 16.58% for the period 1995-2010. For our scenario, let’s be a more conservative in both the future EPS growth rate and the dividend growth rate of the company. Let’s figure the company will grow its EPS by 7% per year and its dividend by 10% per year for the next 10 years. Year Estimated EPS (Growth of 7%) Estimated Dividend (Growth of 10%) 2010 $11.40 (Estimated) $2.50 ($0.65 remaining) 2011 $12.20 $2.75 2012 $13.05 $3.03 2013 $13.97 $3.33 2014 $14.94 $3.66 2015 $15.99 $4.03 2016 $17.11 $4.43 2017 $18.31 $4.87 2018 $19.59 $5.36 2019 $20.96 $5.89 2020 $22.43 $6.48 The investor who invests in IBM could pocket an estimated income of dividend of $44.48 until December 31, 2020 assuming a 10% growth of the dividend of the company per year. Here would be 3 possibilities of the value of the stock and what would be the total return at the end of 2020, assuming different P/E ratios based on an EPS growth of 7% per year and an investment in IBM based on the current price of $146.92. With a P/E of 10: EPS of $22.43 X 10 = $224.30 Return: 82.94% (paid dividends included) (Compound annual return of 6.22%) With a P/E of 11: EPS of $22.43 X 11 = $246.73 Return: 98.21% (paid dividends included) (Compound annual return of 7.08%) With a P/E of 12: EPS of $22.43 X 12 = $269.16 Return: 113.48% (paid dividends included) (Compound annual return of 7.88%) Based on a dividend per share in 2020 of $6.48 and an EPS of $22.43, that would give the company a payout ratio of 28.89%, which is slightly higher than the actual TTM payout of 21.84%. The yield of IBM would be 2.41%, 2.63% or 2.89%, assuming our 3 P/E scenarios of 12, 11 and 10 (Stock price in 2020 of $269.16, $246.73 or $224.30) reflecting a more mature company in 10 years than today thus a higher yield. Another way to justify a future potential stock price of $224.30, $246.73 or $269.16 for IBM is with the price/sales ratio (P/S). We previously saw that the average P/S ratio of IBM was 1.73 for the period 2000-2010 (2010 TTM). Let’s make another scenario for the company’s sales growth rate and its reduction of outstanding shares until 2020. The compound annual growth rate of the sales of IBM has been 2.30% for the period 1991-2009. Let’s presume the same growth rate of 2.30% for the company’s sales per year until 2020. For the period 1991-2010, the company bought back an average of 53,432,291 shares per year. Let’s be more conservative and presume the company will buy back its shares at a rhythm of 40,000,000 shares per year, meaning 400,000,000 less outstanding shares in 2020 compared to today. Here is a table that summarizes the complete scenario. click to enlarge Based on sales of $122,442,000,000 and outstanding shares of 872,800,000 in 2020, the P/S ratio would be at 1.60, 1.76 or 1.92 with our stock price valuations of $224.30, $246.73 and $269.16, respectively. The average P/S ratio of the company for the period 2000-2010 (2010 TTM) was 1.73. These 3 future potential valuations giving a P/S ratio of 1.60, 1.76 and 1.92 match very well with the average P/S ratio of the company for the years 2000-2010. Finally, let’s check what our 2020 projections mean for some other different measures. The net income of the company would be at $19,576,904,000 (EPS of $22.43 X 872,800,000 shares). With that net income, the company could pay dividends of $5,655,744,000 ($6.48 X 872,800,000) and could repurchase its common stock by an amount of $9,869,200,000 ($246.73 X 40,000,000). The market capitalization would be $215,345,944,000 ($246.73 X 872,800,000). Finally, the profit margin would be at 15.99%. ($19,576,904,000 / $122,442,000,000). The actual TTM profit margin is 14.67%. All these different measures make sense and we feel comfortable with our hypothetical projections. The fundamentals of the company are all great: the stock has momentum and is trading at only $0.01 from its all-time high of $146.93, volatility lower than the market , excellent past return of the stock compared to the market, current yield at 1.77%, safe and rising dividend, growing EPS at record levels, global company with a high proportion of the sales coming from foreign markets, good profit and operating margin, correct P/E and forward P/E, and finally, the company has a very strong history of buying back shares. Moreover, assuming our hypothetical scenario of the growth rate of the company’s EPS and dividend for the coming years, the potential return would be in the range of 82.94% to 113.48% by the end of 2020 (compound annual return of 6.22% to 7.48%). Finally, assuming an annual dividend of $6.48 in 2020, still with our hypothetical scenario, the yield of the investor who invested in the stock at $146.92 would be 4.41% at that moment and should continue to increase over time: that is the reward of long term investing, and IBM definitely rewarded its long term investors over time. Despite the “flat sales” of the company, IBM is still a money machine that produces more than $14B of profit per year, and that profit should continue to increase over the years. Even with “flat sales”, IBM is a profitable and valuable company. Source for company description: Morningstar, Inc. Disclosure: Long IBM and SPY... Read more

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