How To Play These 3 Popular Stocks
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Warren Buffett may like IBM (NYSE: IBM) for its stability and safe income yields, but as a value investor I don’t see much upside left. Its multiples are fairly reasonable at around 14.5x past earnings, but the company’s future growth forecasts are not meaningfully above the weighted average cost of capital. What I mean by "meaningfully" is that peers will likely have stronger value creation.
Accenture (NYSE: ACN) is a proven business process outsourcing ("BPO") firm that has yielded high double-digit ROA, ROE, and ROI. The company is predicted to have 10.4% annual EPS growth over the next 5 years, which would put 2016 EPS at $5.55. Taking a multiple of 17x, this translates to a future stock value of $95.35. Discounting backwards by 10% yields a present value of $59.20, which indicates that the current stock is overvalued. As growth investors like to say, "Growth makes premiums irrelevant in a few years". With no long-term debt and a beta of 0.86, Accenture is very safe from the whims of the economy.
Accenture is expecting to grow its top-line by around 9% for this year, but then to decelerate by nearly 50% the following year. IT spending is soft in Europe, but Accenture is offsetting the headwind with consistently increasing EBIT margins. Should the business move towards consulting, margins would increase even more - unfortunately, the demand there is starting to weaken. The outsourcing portion of Accenture’s business should still receive consistent, if not growing demand, from a business population that is increasingly on the hunt for lower cost processes.
According to IDC, a market research firm, global spending on services will grow by a CAGR of 4.5% over the next 5 years and hit $1.1 trillion. IT outsourcing spending will be 10 bps higher whereas IT consulting revenue will be 70 bps lower over the same time period.
A cash chest of nearly $6 billion will enable Accenture to take over various businesses abroad and thereby establish greater inroads into the 48 countries under current operation. Free cash flow has grown by a CAGR of 15% over the last decade, which was above the weighted average cost of capital and led to the stock consistently yielding strong returns.
Analysts are even more bullish on the growth rate of IBM over the next 5 years, which I believe has set the bar low for surprise misses. Solid ROA, ROE, and ROI contribute to IBM being an attractive defensive play; but, again, this comes at the cost of good upside. If you want the flip side of IBM, consider buying rival hardware-maker Dell (NASDAQ: DELL).
Dell trades at half of its historical 5-year average PE of 12.8x and generates considerable free cash flow. For the TTM ending April 30, 2012, the company generated $500 million more in free cash flow on $4.2 billion versus one year ago. At the same time, profit margins have increased. For a business that has hovered around the $20 billion valuation, it makes a considerable amount of free cash flow. Dell could easily use this money to pay off the costs of a takeover within a few years.