Short-Sighted Investors Made This Blue-Chip A Steal

Wednesday, February 4, 2015 - 12:00pm

by Jackson Cusick

 

Sometimes good companies get beaten down by short-sighted investors. When that happens, it is good news for savvy investors.

 

In 2012, Apple, Inc. (NYSE: APPL) fell more than 18% in less than two months following the release of the iPhone 5 and iPad mini, when investors became nervous that the company had reached its creative and competitive peak.

 

Monsanto Co. (NYSE: MON) sank 44% in the first half of 2010 when its licensing practices were called into question.

 

International Business Machines Corp. (NYSE: IBM) suffered a near 40% share price drop in late 1992, following its attempt to compete with the newly-popular personal computer.

 

Now look at where the first two companies are today: After continuing to fall another 25%, Apple has since climbed nearly 60%. Monsanto is back up 158% since its fall in 2010.

 

In 1993, IBM was in the midst of a downturn even worse than the other two I just mentioned. When Louis Gerstner finally stepped in as CEO in April 1993, the company was posting losses of $8 billion per year.

 

But, through an intensive corporate restructuring -- selling off unprofitable divisions, integrating its strongest service offerings and trimming its workforce -- Gerstner led a turnaround of more than 150% in little more than four years.

 

By the time he stepped down in 2002, IBM raised annual revenue to $7.7 billion, from $3 billion in 1994, and its share price had leapt more than 800% from when he first took control of the company.

 

Today, CEO Ginni Rometty appears to be taking the very same measures to bring IBM out of the revenue slump that began in 2011.

 

IBM's shares currently trade 23% lower than its 2013 highs, but if this time is anything like the last, then this selloff is unwarranted and IBM holds great value for patient investors.

 

You see, IBM is in the middle of a transition period. And while in Gerstner's time the company needed to simplify and strengthen its core IT services, Rometty must shed the old technologies that drag it down and embrace those with more growth and profit potential, like the cloud, mobile and security.

 

And this is exactly what investors who ditched IBM back in October failed to see.

 

There are significant costs involved in bring a company of this size back to health. There is simply no way for a restructuring of this scale to be done without a few down quarters. But if you can look beyond the hard time, IBM could very well be poised as a contender among younger companies like Google, Amazon and Microsoft -- all of which are leaders in the sector IBM has in its sights.

 

In October, IBM sold its x86 server division to Chinese tech firm Lenovo for $2.1 billion and began a three-year process of selling off its semiconductor division to GlobalFoundries for $1.5 billion. IBM's revenue from its hardware divisions is down 26% since the fourth quarter of 2013., These divisions have been operating at a loss for the past several years.

 

As IBM has been divesting itself of its leaky and stagnant divisions, it has been investing itself in the rapidly growing market for cloud-based IT services. In fact, in  Q4 2014, IBM's revenue from its cloud ventures increased 60% to $7 billion from the year before.

 

Part of its success results from its new cloud marketplace, which is being compared to Apple's App Store and Google Play for consumers looking to try out its newer suite of software services.

 

IBM will cut costs by laying off nearly 10,000 employees (many of whom are simply being absorbed by companies like Lenovo and GlobalFoundries), but management said the company will hire up to 15,000 new staff with the skills to bolster its profitable divisions.

 

Like I said above, IBM is mounting a colossal turnaround, which could take years to fully accomplish. The good news: IBM's current contracts essentially guarantee a stable revenue stream for years to come.

 

You see, a large portion of IBM's revenue comes from recurring contracts with its corporate clients. Although demand for its hardware and data storage services is in decline, current customers are reluctant to migrate to other platforms.

 

Moving an entire computer network off of IBM's servers is expensive, and as long as the systems do their job, there is little reason for change. This makes IBM's services nearly inextricable from the businesses they currently serve, which ensures IBM's wide economic moat will remain strong for many years to come.

 

Risks To Consider: IBM has been slowed down by the lack of growth in demand for IT hardware. If it is unsuccessful in reducing its involvement in that sector, then its recent downturn could become more than just a phase. There is also widespread doubt concerning new CEO Ginni Rometty's ability to turn IBM around after missing her predecessor's tall revenue promises.

 

Action To Take --> The market's squeamish response to IBM's recent performance has brought the share price down to an extremely attractive range for savvy long-term investors. With a forward price-to-earnings ratio of 9.63, a massive revenue backlog and strong moves into the cloud computing sector, IBM is a company that's not about to disappear. Pick up shares of this tech giant before the market remembers the true value of a blue chip like IBM.

 

Stocks like IBM are similar to a special group of securities we call "Forever Stocks." These world-dominating companies control deep economic moats allowing them to fend off competitors. And they pay investors fat dividends while buying back massive amounts of stocks, which boosts the value of their remaining shares. These stocks are strong enough to buy, forget about and hold forever. To learn more about them -- including some names and ticker symbols -- click here.

 

 

Jackson Cusick 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.