“We just gave you the numbers on IBM. Big Blue $3.59 per share versus estimates of $3.47. Revenue came in at $27.2 billion versus $27 billion.” — CNBC’s The Closing Bell 1/19/2010
Investors were bullish on International Business Machines (IBM) coming into their quarterly report on Tuesday afternoon, as stock finished near its all-time high price above $134 per share. And why not? Management at IBM seems to have this game figured out, and has the company pointed in the right direction on practically all fronts. The optimistic tone of the market heading into the close reflects bullish whispers on the trading floor for the world’s largest computer services company. A company like IBM carries a lot of weight for the rest of the technology sector, and any earnings surprise would help to confirm an ongoing recovery in corporate IT spending.
The confidence in Big Blue was not misplaced as the company came out with better than expected results for the fourth quarter. IBM earned $3.59 or twelve cents better than the consensus analysts’ estimate, and the results even topped the most bullish analyst by a penny. In addition, investors want to see top line growth in these reports as the estimates were for 4Q09 revenue to be flat, but it did in fact grow about 1%. Gross margin improved to 48.3%, continuing its impressive record of growing margins in 21 of the last 22 quarters. Furthermore, service signings were very strong rising 9% to $18.8 billion bringing the estimated services backlog to $137 billion.
For the year, IBM booked record net income of $13.4 billion, and had its seventh straight year of double-digit EPS growth. Diluted EPS grew 13% to $10.01 per year, and free cash flow topped $15.1 billion, again, a record for the firm. For the year ahead, IBM looks to continue its strong performance and double digit earnings growth and now forecasts a minimum EPS of $11 per share, which is slightly higher than expectations.
As you can tell, IBM is taking full advantage of the turnaround in technology and services spending and continues to raise the bar for itself. Interestingly, as of this week’s report we downgraded IBM to Fairly Valued rating from Undervalued because the company’s success is being adequately recognized by the market. Based on current fundamentals, we think IBM should trade for between $121 and $152, so at a price in the mid $130s IBM is not cheap. For example, over the past ten years the market has been willing to pay 1.42x to 2.14x revenue per share for IBM. The current price-to-sales metric sits comfortably in that range at 1.83x, and it is a similar story when it comes to price-to-cash earnings metrics.
IBM’s fourth quarter demonstrates that the company is performing quite well, and that could be a great thing for the technology sector going forward. Big Blue is managing impressive earnings growth and margin expansion and they deserve credit for that. That being said, IBM’s story is well known to the market and it is no longer a great buy at these price levels. We would advise investors to look to some of the lesser known success stories in the tech sector to take advantage of this trend.
