Ignore The Headlines -- This Blue Chip Is Still A Buy

Tuesday, October 20, 2015 - 12:30pm

by Jim Nelson

One of the best ways to make money in the market is to find areas where mainstream investors are simply looking at the wrong numbers.

For example, take a look at International Business Machines Inc. (NYSE: IBM).

IBM is the glue that holds all of the modern-day tech world together. 

Not only has this company long been the guiding hand in making technology so important these days; it also continues to control a large swath of the hardware side of the industry.

The company still makes servers and storage solutions for huge organizations like the Department of Defense and Google. In fact, it is making great strides in competing with Intel (Nasdaq: INTC) on that front.

But it's IBM's other operations that should have investors taking note. 

IBM is an industry leader in some of the most important new trends in the tech world is analytics: cloud computing and big data,. For instance, big data studies how users are accessing information and exactly what kind of information they are accessing. IBM's big data solutions include the systems and sensors that tally that info to report back to the Googles and Amazons (Nasdaq: AMZN) of the world.

Of course, to continue to compete, IBM has to evolve and stay ahead of the game. So of late, the company has been making serious strategic moves to position it to compete in years and decade ahead.

That's where investors are getting IBM wrong. They are looking at the wrong number on IBM's financial scorecard.

The Investors' Folly
On Monday, October 19, the company reported its third quarter earnings figures. Its revenue fell 14% year over year. And as you might expect, shares are falling today.

Of course, if you've ever run a business or even been around those who have, you know you can't use a single number on a single quarter's worth of operations to judge the company on the whole.

And in IBM's case, investors just can't look at its reported top line and tell anything.

The company is undergoing an enormous restructuring. That means divestitures, retooling operations and cutting costs. However, all of those things can wreak havoc on short-term revenue.

That doesn't even touch on the single most flawed takeaway investors found in the recent quarter: currency.

The dollar has been incredibly strong against almost every other currency in the world of late. That was especially true in the third quarter. Of course, currency fluctuations tend to revert back to the norm at some point.

So if you take the dollar's strength out of IBM's numbers as well as its divestitures (how can you count a business it no longer has), that 14% drop turns into just a 1% decline in sales.

Instead, here are the real numbers investors should have taken away from yesterday's earnings:
•    Sales from its strategic initiatives grew 27% on the quarter after adjusting for currency and divestitures.
•    Cloud computing revenues jumped 65% -- one of IBM's most lucrative growth segments.
•    Its analytics segment sales were up 19% year to date.
•    Free cash flow grew 1.2% in the first nine months of the year.

That last line is crucial to understanding the company -- and it is something investors are missing.

Free cash flow is a much more important number to look at when judging a company that is going through structural and industry-related changes.

Earnings include items like divestitures and one-time cost cutting expenses. Free cash flow shows how much actual money a company made during a given period of time. 

And for IBM, it is still a cash machine.

The company is also using that cash to reward shareholders better than almost all other large tech companies you can find.

IBM has paid a dividend every year since 1916. That's nearly 400 uninterrupted quarterly payments. It's also grown those dividend checks consistently for the last 20 years... even facing the dot-com bust and the 2008-09 Great Recession.

It is also spending a substantial amount of its enormous free cash flow on share buybacks. Meaning it is taking advantage of investors' current undervaluation of its shares by simply taking them off the market.

In the most recent quarter, IBM spent $1.5 billion on its own shares. That's on top of its $1.3 billion dividend payment.

If you look at its $13.6 billion in annual cash flow and its $9.6 billion in cash on hand, not to mention its growing margin through its recent cost-cutting initiatives, you're looking at a company in tremendous financial health.

Yet investors have simply concluded that since its reported earnings fell this quarter, it's time to sell the century-old tech giant. 

If you are a long-term investor, who enjoys receiving steady dividends from a shareholder friendly company, look no further than IBM at these prices.

Risks To Consider: IBM continues to face pressures on its traditional hardware businesses from Intel and now Advanced Micro Devices (Nasdaq: AMD). However, its strategic push to create space for itself in everything from analytics and cloud technologies has and will more than make up for any lost market share on its servers and power businesses.

Actions To Take: Consider buying shares of International Business Machines Inc. (NYSE: IBM) on today's share price dip. With it trading at such a low post-earnings price, its dividend now yields 3.5% -- something almost no other tech company can offer.

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Jim Nelson does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.