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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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