How Does IBM Keep its Edge?

Daniel is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The technology sector has been taking hits right and left in the last few months. PC makers have been especially affected, as I noted in an article last week. In this battleground, there are a few companies left that have been outperforming the tech sector as a whole. One of these is International Business Machines, better known as IBM (NYSE: IBM). In recent years, IBM has been ahead of its rivals consistently, and appears well positioned for the future. In this article I will examine some of the reasons IBM has been able to maintain its competitive edge.

IBM is the largest IT company in the United States, with a market cap just shy of $215 billion and almost 450,000 employees. The company’s operations are divided into software, services, and hardware divisions; of which software accounts for about 45% of total profits and services for 40%. Both of these divisions are strongly geared towards enterprise customers.

PC makers, who to some degree compete with IBM’s hardware division, have been reporting deeply troubling numbers. Dell’s (NASDAQ: DELL) net income was down a massive 47% in the last report, and HP (NYSE: HPQ) has been faring little better with a drop of 16% in consumer PC revenue. On the other hand, IBM has outpaced analyst expectations. This is mainly because IBM is no longer just a PC maker, it is a tremendously varied IT company with a strongly diversified product portfolio across several industries. Its strength in the more defensive IT services segment has given it somewhat of a safe haven status in the tech world, and has allowed it to weather the crisis better than most competitors.

EPS has somehow beaten analyst expectations every single quarter since Q1 2009, which happens to be as far as my data goes back. This is no small feat. Moreover, in the same time frame, EPS growth as well as dividend growth has generously outpaced the industry. In the most recent report, EPS beat by about a penny, but revenue eased some 5% largely due to negative currency impact and a few large deals falling through.

The valuations metrics for IBM are as follows. The stock trades at 13.66x earnings, more or less on par with the industry average. The operating margin is a decent 20.83%, but the real kicker is the absolutely staggering 73.84% return on equity. This higher than almost any stock I have encountered. Debt is a bit of a problem though, as the total debt to equity ratio stands at over 150. However, IBM does offer a forward yield of 2.4% at a payout ratio of 35%. Accenture PLC (NYSE: ACN), who competes with IBM in the IT services segment, trades at a higher 17.68x earnings with a lower operating margin of 13.9%. Return on equity is almost as impressive as IBM though at around 63%.

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To recap, IBM appears to be outperforming the industry. This is largely due to their well-diversified product and service portfolio, and strength in the more durable and defensive segments of the tech sector. Earnings have been consistently impressive over the last few years, certainly better than the competition in the PC hardware arena. Moreover, the current valuation looks quite attractive to me, which makes IBM appear a solid pick for a long-term value play.


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