After Post-Earnings Plunge, Is This Stock an Opportunity?

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

For the first time in years, International Business Machines (NYSE: IBM) missed analyst estimates, and reported weaker-than-expected earnings and revenue. As a result, the company's stock plunged over 8% last week. Has the market overreacted? Are current price levels an opportunity for value investors?

Valuation

After the recent earnings report and price drop, it is interesting to see how the valuation ratios for IBM are now. With regards to P/E, the stock is currently trading at 13.19 times earnings, which is slightly lower than the industry's average, and better than competitors like Accenture (NYSE: ACN), which has a P/E of 16.18, or Hewlett-Packard (NYSE: HPQ), which does not even have a positive P/E as its EPS is negative.

When taking into account future earning estimates, IBM is also in decent shape. With a forward P/E of 10.29, the stock seems undervalued compared to most of its peers (like Accenture, which trades at a forward P/E of 16). However, Hewlett-Packard seems to be the most undervalued of the lot if future earning estimates are to be trusted, as its forward P/E is only 5.46.

IBM's P/B is worryingly high at 11.26, higher than the industry's average and higher than Accenture's 9.35, and Hewlett-Packard's 1.67. When factoring in growth, however, IBM comes out in a strong position: Its PEG is 1.26, better than most of its competitors. It cannot be said that IBM is a drastically undervalued stock, but it does have better valuations than most of its competitors in areas like P/E or PEG. Its high price-to-book ratio, however, is a bit worrying.

Analysts

Analysts are neutral to slightly bullish on the stock. It has an average recommendation of 2.40 (overweight-hold), better than Hewlett-Packard's 3.20 (hold-underweight), but slightly worse than Accenture's 2.10 (overweight). However, with regards to price targets, IBM's average price target of $225.57 implies that the stock has an almost 20% upside potential from current stock prices.

Accenture's implied upside is less than 8% and Hewlett-Packard's current stock price is actually higher than its average price target. However, one should note that very few IBM price targets have been published after its last earning report and subsequent stock price plunge, so it its likely that, as analysts adjust their price targets to the post-earnings scenario, the almost 20% implied upside for the stock will erode.

<table> <tbody> <tr> <td> </td> <td><strong>P/E</strong></td> <td><strong>Fw P/E</strong></td> <td><strong>P/B</strong></td> <td><strong>PEG</strong></td> <td><strong>Avg Rec</strong></td> <td><strong>Avg PT (%Implied Upside)</strong></td> <td><strong>Div Yield</strong></td> </tr> <tr> <td><strong>IBM</strong></td> <td>13.19</td> <td>10.29</td> <td>11.26</td> <td>1.26</td> <td>2.40</td> <td>$225.57 (+18.4%)</td> <td>1.79%</td> </tr> <tr> <td><strong>ACN</strong></td> <td>16.18</td> <td>16</td> <td>9.35</td> <td>1.42</td> <td>2.10</td> <td>$79.63 (7.6%)</td> <td>2.17%</td> </tr> <tr> <td><strong>HPQ</strong></td> <td>-</td> <td>5.46</td> <td>1.67</td> <td>-</td> <td>3.20</td> <td>$19.07 (-2.51%)</td> <td>2.71%</td> </tr> <tr> <td><em>Edge</em></td> <td><em>IBM</em></td> <td><em>HPQ</em></td> <td><em>HPQ</em></td> <td><em>IBM</em></td> <td><em>ACN</em></td> <td><em>IBM</em></td> <td><em>HPQ</em></td> </tr> </tbody> </table>

Price movements

Had it not been for Friday's drastic +8% drop in the stock price, IBM would have been up almost 10% this year. After the drop, it is now actually almost 1% down this year. Since its late-2008 lows of $80, the stock has risen 135.75%, in almost a perfect straight line, with no major ups and downs. Friday's drop is clearly the exception.

The stock is now 12% off its 52-week high of $215.90, and only 5.83% above its 52-week low of $179.54. Even though the likelihood that the stock will recover some lost ground this week is high, it might be harder for IBM to hit new 52-week highs anytime soon. 

Dividend

The company has been a consistent dividend payer since 1987, never once scrapping it in 26 years. It currently pays a quarterly dividend of $0.85/share, which works out to an annualized yield of 1.79%. However, even with Friday's price drop, the yield is lower than Accenture's 2.17% or Hewlett-Packard's 2.71%.

Earnings: Looking ahead

IBM reported EPS of $2.70, up from $2.61 reported in the prior quarter. However, analysts were expecting EPS of $3.05, so, the earnings disappointed many. IBM's Senior Vice President attributed the weak earnings to two main causes: The inability to close some profitable deals prior to the end of the fiscal quarter, and a weaker Japanese yen.

With regards to the inability to close deals before the deadline, the argument is valid (as the deals are worth around $400 million), but certainly does not explain why the company's revenue was so weak: The gap between the estimated revenue and the reported revenue is almost $1.5 billion. This is not something that can be attributed to missing a deadline for deals worth only $400 million.

The losses attributed to the Yen's drastic depreciation this year are legitimate, and relatively hard to hedge as most of Japan's revenue comes from service operations, and are therefore conducted in Yen. The company was far from weak in Japan, however, as it actually experienced higher revenue growth in Japan than in the Asia/Pacific region as a whole. 

Other causes probably played a role in the weak earnings: Lowered government demand due to budget cuts in both the U.S. and Europe, product transitions and shifts in technology, and general macroeconomic concerns weighed down demand for products.

That being said, the company also reported healthy margin gains and a drop in total expenses, as well as a slight growth in cash. This has been a pattern for the company for the last few quarters, and is an encouraging sign that points to a rise in productivity and a more favorable revenue mix.

The company also reported a rise in its order backlog, which, coupled with the $400 million in deals, a possible slowdown of the Yen's drop, and better worldwide economic conditions, could bring better earnings next quarter. The company has actually kept its 2013 outlook unchanged. Current analyst earning consensus for this year is at $16.74/share.

Bottom line

It is understandable that the weak earnings disappointed many investors. However, IBM remains one of the strongest tech companies out there. The recent stock price plunge has driven valuation ratios down, so these price levels could be good entry points for value investors who believe that the company's weaker-than-expected results were part of an off-quarter, rather than a sign that IBM has reached a point of declining growth and earnings.


Alex Bastardas has no position in any stocks mentioned. The Motley Fool recommends Accenture. The Motley Fool owns shares of International Business Machines.. 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!

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