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Stock Pick of the Week: Buy International Business Machines (IBM)

Tuesday, August 17th, 2010

IBM is one of August’s Most Attractive Stocks. And like all of our Most Attractive Stocks the company has (1) high and rising economic profits (as distinct from accounting profits**) and (2) a cheap valuation. As shown in our report on IBM, the company’s ROIC is in the 2nd Quintile of all the companies we cover. At the same time, the stock boasts a 10% FCF Yield and our dynamic discounted cash flow analysis shows the current stock valuation implies that the market believes IBM’s profits will decline by 10% and never grow after that decline. In other words, the stock is priced for permanent profit contraction – no growth ever.

HIDDEN GEM: Our detailed valuation model shows that IBM grew its “economic” profits more than it accounting profits during its last fiscal year. Economic profits rose by $1.15bn while accounting profits rose by $1.09bn. For details on what causes the difference between Economic Versus Accounting Profits, see Appendix 3 on page 10 of our free report on IBM.

See Appen­dix 4 to learn how IBM increased NOPAT by cut­ting costs and increased its NOPAT Mar­gin. See Appen­dix 5 for details on how IBM cut its Invested Cap­i­tal to offset the drop in revenue and keep its Invested Cap­i­tal Turns close to 1.0. Appen­dix 7 (in the Return on Invested Cap­i­tal sec­tion) shows how the improved NOPAT Mar­gin and steady Invested Cap­i­tal Turns result in an increase in ROIC (to 14.1% from 12.1%) and Eco­nomic Profit, which rose by $1.15bn while Net Income rose by only $1.09bn.

As per and , IBM fits the profile of a great stock to buy.

**See and Economic Versus Accounting Profits for more detail on why accounting profits are not reliable indicators of corporate profitability or value creation.

Note: Stock pick of the week is updated every Tuesday.

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3 Comments

  1. varadha says:

    Terrific, yet simple analysis. I’ve always been a fan of ROIC as a measure of capital efficiency and believe that no size/growth outperformance can replace the quest for efficiency.

    Sort of like a big gas guzzling v8 that needs ever increasing gallons of fuel to keep its engine running

  2. David says:

    But Angie’s $90 per user acquisition cost is going to go away. That’s what their approach probably is. How would their outlook be if that $90 cost dropped down to a total cost of $3 per user?

  3. David:

    That would be great, but cost per user acquisition is not something that’s very easy for a company to fix. ANGI can slash their marketing budget to the bone, but then they would stop acquiring new members. They would probably lose members in fact, as their membership renewal rate is at ~75% and declining. If they cut marketing expense by ~95% as you seem to be suggesting, ANGI might be able to eke out 1 year of slight profits, but they would start shedding members and losing money very quickly. ANGI’s only hope is to keep its marketing budget high and hope it can reach the scale and brand awareness to be able to sustain its business while scaling back marketing costs enough to turn a profit. The fact that ANGI’s revenue growth is slowing down even as its marketing costs keep increasing makes it very unlikely it will achieve that goal.

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