What Does Billionaire Jim Simons’ Renaissance See in IBM?
Meena is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Several weeks after the end of each quarter, hedge funds file 13Fs with the SEC to disclose many of their long equity positions in U.S. stocks to the general public. We track hundreds of 13Fs, using the included information to help us develop investing strategies; we have found, for example, that the most popular small cap stocks among hedge funds earn an average excess return of 18 percentage points per year (learn more about our small cap strategy).
Because we keep track of filings over time, we can also look for major changes in top managers’ portfolios. When we reviewed the 13F from Renaissance Technologies for the first quarter of 2013 (Renaissance’s founder, Jim Simons, has since become a billionaire), we noticed that the fund increased its stake in International Business Machines (NYSE: IBM) by over 450% since the beginning of the year, to a total of 2.3 million shares. This made it one of Renaissance’s five largest holdings overall (check out more of the fund's stock picks).
IBM’s revenue declined 5% last quarter compared to the first quarter of 2012, with sales and services revenue each falling. While costs were also lower, pre-tax income ended up dropping 6%, though a lower effective tax rate caused earnings to be more or less unchanged (and a decrease in share count resulted in an actual increase in earnings per share). During the quarter, IBM generated over $4 billion in cash from operations; with little cash being used on investing activities (except for that used to purchase marketable securities) the company was able to dedicate most of this cash flow to buying back stock, with moderate dividend payments (the annual yield is just under 2%) as well.
The stock currently trades at 14 times trailing earnings. We’ve seen that while revenue and net income have not been doing particularly well, IBM can drive small increases in EPS through buybacks. As a result, we would expect earnings per share to grow at least slightly going forward, and Wall Street analysts agree with their projections implying a forward P/E of 11. Warren Buffett’s Berkshire Hathaway is also a fan of IBM, having reported a position of over 68 million shares as of the end of March (find Buffett's favorite stocks).
Peers of IBM include Accenture (NYSE: ACN) and Hewlett-Packard (NYSE: HPQ). Hewlett-Packard has been moving away from hardware and towards software and services, as IBM has done; the stock currently trades at 7 times forward earnings estimates. While revenue and earnings both fell at double-digit rates in the first quarter of 2013 versus a year earlier, we’d keep an eye on HP for any signs of stabilization.
Recent performance has been better at Accenture, with recent reports showing rises on both top and bottom lines. However, the market has already priced in some future growth at the company, with the stock carrying a trailing P/E of 19. Still, it’s possible that Accenture is worth this premium to HP and IBM.
We can also compare IBM to Microsoft (NASDAQ: MSFT) and to Dell (NASDAQ: DELL). Each of these companies is valued at 11 times consensus earnings for the next fiscal year, though there’s a complication in each case. Dell is facing competing bids for the company from Silver Lake Partners and from billionaire activist Carl Icahn. Currently, the stock is valued at $13.40; the Silver Lake offer is $13.65 per share, while Icahn is trying to line up enough financing to offer $14.
While returns on this investment would be low in absolute terms, they might look more attractive at an annualized rate. In Microsoft’s case, we’d be concerned that the low earnings multiple reflects a temporary boost to EPS from sales of Windows 8 and the new version of the Office software. As a result, investors would have to model out the company’s financials for a few years beyond that point to better evaluate the company’s valuation.
IBM seems that it may be about fairly valued: the earnings multiples are in line with slight increases in earnings per share going forward, and at least at this point, the company seems to be able to deliver exactly that through repurchases. It wouldn’t be a buy, however, unless we were convinced that management could join its buybacks with improvements in the actual net income as well.
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This article is written by Matt Doiron and edited by Meena Krishnamsetty. Meena has long positions in Microsoft and Dell. The Motley Fool recommends Accenture. The Motley Fool owns shares of International Business Machines. and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!