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Buy for Dividends and Capital Appreciation

Wednesday - 1/30/2013, 11:50am  ET

International Business Machines has reported another stellar quarter and its stock has since then appreciated approximately 5%. The company has beaten analyst earnings estimates for the 4th consecutive quarter. IBM remains one of the best technology bets around due to its high earnings visibility and track record of surprising the market with diversified growth. According to company disclosures it is aiming for a $20 EPS by 2015 and is focusing on its software segments. I believe, with a dividend yield of 1.7% and strong case of capital appreciation; IBM is still the safest and surest technology bet.

 Earnings Review

This Tuesday, IBM maintained its excellent record of beating consensus estimates. The Big Blue reported an EPS of $5.39, 2.7% above consensus estimates of $5.25. The company reported a 1% y/y decline in revenues of $29.3 billion. The stock appreciated approximately 4% on earnings in aftermarket trading. The market has responded positively to the beat and its long term strategic shift to software.  

During the last few quarters the company has suffered from currency fluctuations because a strengthening dollar negatively impacts its imported revenues. However, this quarter, at constant currency, the revenues were flat yoy but declined 1% otherwise. There was a significant increase of 11% yoy in EPS and 14% yoy increase in operating profit. The net income for the quarter was $5.8 billion as compared to $5.5 billion in 4Q2011, a yoy increase of 6%. According to the company, disclosures the stellar performance for the quarter was driven by superb growth in cloud computing, smarter planet solutions, and analytics.

In the last couple of years IBM has divested large parts of its hardware business. This is because the company is shifting its focus from hardware to software based solutions, especially analytics. The future focus is primarily on big data, mobile solutions, security, social business, and offering existing solutions to new markets. The company also disclosed that it is targeting an operating EPS of $20 in 2015.

Key Takeaways

The company has successfully driven revenue growth from emerging markets and other high growth markets. Its software, cloud, and smart planet solutions have played a key role in driving growth in revenues during a sluggish economic scenario. The revenue from high growth markets has increased by 7%, as compared to a 4% increase during last quarter.

The margin improvements are a particular sign of comfort for investors because most companies have been facing reduced margins due to weak economy. The company reported gross margins of 52.3% above sell side estimates of 51.4%. This strength in margin has been driven by improved operational efficiency particularly in hardware and high revenue contribution by the more profitable software services.

The company has maintained solid growth in Wallet and it seems this growth is coming at the expense of other major market players. According to sell side estimates HP and Xerox can be the major players losing enterprise share to IBM. This can be very bad news for HP and Xerox investors because these companies are relying heavily on their enterprise segments for profitability.

Xerox

The loss of revenue from its enterprise segment might seem a trivial matter but when your core business is struggling, every penny counts. To say Xerox is struggling is an understatement as the company has lost almost half its value in the last five years. It has failed to manage its falling revenues in the printing segment and inability to diversify effectively or quickly to compensate for the decline. The company has shown revenue growth of 2% in the last five years. Trading at a forward P/E of 6.9x and very near its 52 weeks high, it seems the stock is overbought. 

HP

HP is already suffering from falling printer and PC sales. The autonomy crisis has left last year’s largest printer and PC manufacturer in serious trouble, any bad news from its enterprise segment can create havoc on the share price. At a forward P/E of 4.7x, it is still a much better option than its struggling competitor Xerox. The former printer giant has more diversified revenues as compared to Xerox and its PC business can stabilize once the initial handheld frenzy settles down.

Outlook

IBM is focusing on the software side of its business especially analytics. The company is my top pick for both capital appreciations and dividends. It is still the leader in mainframe industry and its success in analytics hint that the 2015 target of a $20 EPS is reasonable.

This article was originally published as Buy for Dividends and Capital Appreciationon Fool.com

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