IBM: Gauge Analysis (updated February 23, 2021)

I have analyzed IBM's financial statements to determine whether the company's shares can be considered a good value and reasonable risk for prudent investors. My analytical approach was inspired by Benjamin Graham's recommendations in "The Intelligent Investor," which was first published in 1949 and is still one of the best-known books about value investing. I modified Graham's specific suggestions to fit modern times; however, the goal is the same: find stocks that are inexpensive relative to the company's strengths and aren't excessively risky.

The analysis uses gauges to assess how well the company satisfies seven specific investment criteria.  GREEN, YELLOW, and RED grades indicate whether the criteria are fully satisfied, partially satisfied, or not satisfied.  An Overall Score between zero and 100, which takes all gauges into account, is also computed.  While the analysis includes both growth and value criteria, the Overall Score calculation by design favors companies with good value characteristics over fast-growing, but expensive firms.  An Overall Score above 60 signifies the company is worth examining in more detail; a score over 80 is a rare accomplishment.

First, a quick review of the company itself.

IBM was the first major technology company, and it became a colossus selling powerful (for the time) mainframe computers.  IBM made early personal computers, but it sold that business to Lenovo in 2005 when IBM decided to focus on more profitable information technology services for businesses.  Always a research powerhouse, the company developed cloud-computing and artificial intelligence services (e.g., "Deep Blue").  But, IBM has not come close to regaining the dominating market position it had with mainframes.  IBM's annual revenue has been slowly declining for years. IBM took a big step towards repositioning the company around the "hybrid cloud" when it spent $34 billion to acquire Red Hat, a leading open-source software firm.  However, the jury is still out on whether IBM can compete effectively against the giants of the cloud business, which include Amazon, Microsoft, and Google.  In October 2020, IBM announced it would take a second restructuring step and spin off its managed infrastructure services unit.  The business to be divested into a new public company is now part of the IBM Global Technology Services division, and it brings in revenue of about $19 billion per year. 

IBM recorded profits of $6 billion, $6.22 per share, on revenue of $74 billion during the last 12 months.  In the quarter that ended on December 31, 2020, IBM earned $1.51 per share on a GAAP basis, and it gained $2.07 per share after non-GAAP adjustments and exclusions.  See IBM's most recent quarterly report and my review of their results relative to expectations for additional information.

Shares of IBM now trade for about $121 each, giving the company a market value of $109 billion. These shares can be found in the Dow Jones Industrial Average, Standard and Poors 500, Standard and Poors 100, New York Stock Exchange Composite, and Russell 1000 stock indices.

Analysis Results:

IBM's grades on the seven investment criteria are listed below, along with some of the financial figures that influenced these color assignments

1. The Company's Size is Substantial: GREEN

    Market Value: $108.7 billion (mega-cap)

2. The Company is Conservatively Financed: RED

    Current ratio = 1.0 (>2.0 is conservative)

    Long-term debt/Equity = 262% (<100% is conservative)

3. The Company Generates Stable Earnings: GREEN

    Nineteen positive quarterly earnings reports in last 5 years (almost perfect)

    Earnings variability = 15% (modest)

4. The Company Exhibits Earnings Growth: RED

    Owner Earnings growth rate (trailing year) = -39% (poor)

    Owner Earnings growth rate (five-year average) = -6% (poor)

    Free Cash Flow growth rate (trailing year) = 25% (very good)

    Free Cash Flow growth rate (five-year average) = 2% (weak)

5. The Company is Efficiently Profitable: GREEN

    Cash Flow Return On Invested Capital = 22% (good)

    Operating Profit/Sales = 8.4% (okay)

6. The Company Pays a Healthy Dividend: GREEN

    Dividends paid for the last 7 years or longer

    Dividend 5-year average growth rate = 4.3% (weak)

    Dividend = 37% of last year's FCF (easily sustainable with room to grow)

7. The Company's Shares are Fairly Valued: YELLOW

    Price/Owner Earnings (last year) = 16.9 (moderate to pricey)

    Price/GAAP Earnings (five-year average) = 13.5 (appealing)

    Free Cash Flow/Market Value = 14.3% (very appealing), more than the five-year average of 10.3%)

    Acquirer's Multiple = 25.3 (very expensive)

    Price/Book Value = 5.2 (less expensive than the five-year average of 7.2)

    Price/Sales = 1.5 (less expensive than the five-year average of 1.7)

In summary, the analysis assigned IBM four GREEN, one YELLOW, and two RED grades.  The resulting Overall Score is 56 of the 100 possible points, which is a good, but not quite high enough result.  The score is below the 60-point GCFR threshold, and, therefore, IBM does not satisfy the GCFR criteria for investment consideration at this time.

The share price would theoretically have to fall by 14.8 percent, from $120.91 to $102.99, all else being equal, to lift the Overall Score to the 60-point threshold. It is also possible that IBM's future results will push the score up (or pull it down).  Revisit GCFR2 occasionally for updates on IBM's performance and the latest GCFR gauges and scores.

This analysis reported here is a limited evaluation of the subject company.  It does not consider all material facts about the company's operations, finances, or future prospects.  The analysis relies on publicly available financial data assumed, but not guaranteed, to be accurate and consistent.  Readers are strongly encouraged to verify all data and perform their own independent analyses.  Other analytical approaches and screening criteria will be more applicable to investors having different goals, circumstances, and tolerance for investment risk.  This post is not and should not be considered investment advice, nor does it constitute an offer or solicitation to buy or sell any security. The author might have a long or short position in the subject company and/or its competitors. The analytical approach, the criteria used, and all calculations are subject to change without notification.

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 #ibm        #gauges  #gcfr  #gcfr2 #valueinvesting   #nac_financialanalysis

IBM: Earnings Report for the Quarter Ending December 31, 2020

IBM reported after the market closed on January 21, 2021, it earned $1.51 per diluted share in the quarter that ended on December 31, 2020, down 63 percent from earnings of $4.11 in the same 3 months of the previous year. These figures are the earnings determined in accordance with U.S. Generally Accepted Accounting Principles (GAAP). 

Operating Earnings from Continuing Operations, a non-GAAP figure, fell 56 percent to $2.07 per share from $4.71 one year earlier, a decline not quite as steep as change than seen in the GAAP figures. The principal exclusions contributing to the $0.56 per share difference in the latest quarter between the GAAP and Non-GAAP earnings were: Acquisition-Related Adjustments [$0.40 per share], Retirement-Related Adjustments [$0.22 per share], and Other [$0.04 per share].  Non-GAAP earnings, by excluding unusual and non-cash items that could obscure the results of a business's principal, ongoing operations, are intended to be cleaner measures of corporate profits.

This post compares the quarterly Income Statement published by IBM to the estimates I made in a previous “Look Ahead” post.  My estimates were based on publicly available guidance provided by IBM's management to financial analysts, news reports, and trends in the company's historical results.  Unless otherwise mentioned, all reported values mentioned below are GAAP figures.

First, a little background about the company:  IBM was the first giant computer company, and it was once one of the largest companies in the world.  When hardware became a commodity product, IBM increased its focus on more-profitable information technology services for businesses.  Always a research powerhouse, the company subsequently developed cloud-computing and artificial intelligence services (e.g., "Deep Blue"), but IBM's annual revenue has been slowly declining for years. IBM started to recreate itself in a more radical way in 2019 by acquiring Red Hat, a leading open-source software firm, for $34 billion.  The next step came when IBM announced in October 2020 it would spin off its managed infrastructure services unit, into a separate company.  This business is currently part of the Global Technology Services division, and it brings in revenue of about $19 billion per year.  

Revenue in the December 2020 quarter totaled $20.4 billion, 6 percent less than last year's $21.8 billion. The Global Technology Services business was responsible for 32 percent of overall revenue, and this unit's revenue percent fell by 5.5 percent compared to the year-earlier result. The Cloud & Cognitive Software business contributed 34 percent of revenue, and this unit's revenue decreased by 4.5 percent. The Global Business Services unit supplied 20 percent of revenue, and this business's revenue fell by 2.7 percent.

I was expecting IBM to report revenue of $20.2 billion for the December 2020 quarter.  The actual amount surpassed my estimate by $167.0 million (0.8 percent).

The Cost of Revenue (also known as Cost of Goods Sold) was $9.8 billion in the latest quarter, which translates into a Gross Margin of 51.7 percent of revenue. Since it was higher than the 51.0 percent Gross Margin achieved in the year-earlier quarter, it signifies that IBM sold its products and services at more profitable prices relative to production costs. I was expecting the Gross Margin to be 48.5 percent in the December 2020 quarter, and IBM exceeded that prediction by 3.2 percent.

IBM spent $1.61 billion on Research and Development in the latest quarter, up from $1.60 billion one year ago. I had estimated that R&D expenses would be $1.62 billion.  R&D was 7.9 percent of Revenue.

Sales, General, and Administrative expenses totaled $7.2 billion in the December 2020 quarter, up from $5.4 billion one year ago.  SG&A expenses increased from 24.9 percent to 35.5 percent of quarterly revenue, and the big increase is due to a ~$2.0 billion charge for restructuring.  

The last operating expense line on the Income Statement is for all other operating income and expenses.  This line amounted to a $173.0 million gain in the latest quarter.  I had assumed the restructuring charge, originally expected to be $2.3 billion, would be listed here and not as part of SG&A.

Operating Income was $1.9 billion in the quarter, down 56.2 percent from the year-earlier period.  Operating Income exceeded my $0.4 billion estimate by $1.4 billion. The better-than-expected Gross Margin and the less-than-expected restructuring charge accounted for much of the difference between the actual result and my prediction.

Interest and other non-operating items summed to a net expense of $564 million.  My estimate was $525.0 million.

The effective income tax rate fell by 6.2 percent to 1.9 percent, which had a positive effect on net income.  I expected the tax rate to be 10.2 percent.

Net income in the quarter was $1.4 billion, $1.51 per share.  The figures for the year-earlier quarter were $3.7 billion, $4.11/share. My EPS estimate was ($0.10).

In summary, IBM greatly exceeded my prediction by increasing its gross margin, incurring a lower-than-expected restructuring expense, and (somehow) having an income tax rate close to zero.

The Cash Flow Statement for the quarter shows that IBM's operating activities generated $5.9 billion in cash during the last quarter, up 69.8 percent from $3.5 billion in the year-earlier period. The cash flow delta was, therefore, much better than the change in earnings. Notable uses for cash included $1.5 billion to pay dividends to shareholders, $299 million for corporate acquisitions, and $1.1 billion to acquire property, plant and capital equipment. 

Free cash flow over the last 12 months totaled $15.2 billion, or $16.86 per share using the latest share count. At the current market price per share of $118.60, this translates into a very attractive Free Cash Flow Yield of 14.2 percent.

This post is not investment advice, and the accuracy of the information, tables, charts, and any commentary presented is not guaranteed.  Readers are encouraged to independently verify all data using information from original sources. The Income Statements discussed in these blog posts have not been audited and may differ in material respects from those published by the subject company.  These differences are intended to facilitate analysis and cross-company comparisons. Complete financial statements with notes can usually be found in the 10-Q and 10-K filings companies submit to the Securities and Exchange Commission (SEC).

 #ibm  #gauges  #gcfr  #gcfr2 #QtrlyRpt   #nac_financialanalysis

IBM: Look Ahead to December 2020 Quarterly Results

This "look-ahead" post discusses how I came up with an estimate for IBM's earnings for fiscal 2020's fourth quarter, which ended on December 31, 2020, by predicting each element of its Income Statement, from top-line Revenue to bottom-line Earnings Per Share (EPS) and everything in between. 

Once the company’s official results become available on January 21, I will compare the published Income Statement to the prediction and identify any surprises, positive or negative.  Examining these differences can identify what factors (e.g., profit margins, non-GAAP expenses, tax rates, share buybacks) are driving changes to a company's financial performance.

But, let's take a step back and start with background information about IBM.

IBM was the first giant computer company, and it was once one of the largest companies in the world.  When selling computing hardware became less profitable, IBM leverage its ties to the corporate world and increased its focus on information technology services for businesses.  Always a research powerhouse, the company subsequently developed cloud-computing and artificial intelligence services (e.g., "Deep Blue"), but, despite seeming advantages, IBM's annual revenue has been declining slowly for years.  IBM started to reinvent itself more dramatically in 2019 when it acquired Red Hat, a leading open-source software firm, for $34 billion.  The next step came in October 2020 when IBM announced it would spin off its managed infrastructure services unit into a separate, publicly traded company.  This business is currently part of the Global Technology Services division, and it brings in revenue of about $19 billion per year.  

With a market value of about $110 billion on a fully diluted basis, IBM is part of the Dow Jones Industrial Average, Standard and Poors 500, Standard and Poors 100, New York Stock Exchange Composite, and Russell 1000

IBM recorded profits of $8 billion on revenue of $75 billion during the four quarters that ended in September.  Revenue in the September quarter totaled $17.6 billion, 3% less than last year's $18.0 billion.  The Global Technology Services business was responsible for 37% of overall revenue, and this unit's revenue fell by 3.6% compared to the year-earlier result.  The Cloud & Cognitive Software business contributed 32% of revenue, and this unit's revenue grew by 6.8%.  The Global Business Services unit supplied 23% of revenue, and the amount fell by 4.7%.  See https://tinyurl.com/y34rev9g for IBM's most recent quarterly report.

My starting point, if available, when estimating earnings is guidance provided by the company's management to financial analysts.  It's true that the company may downplay expectations somewhat to avoid disappointments, but the top managers ought to know better than anyone else how well their products and services are selling.  I also look for other information about the company in the news, and I take advantage of trends in the company's historical results.  While it makes my task a little more difficult, I also try to estimate earnings that conform to Generally Accepted Accounting Principles (GAAP).  Non-GAAP results, which most professionals focus on, are somewhat arbitrary and often exclude meaningful items.

IBM's management did not, as mentioned above, communicate expectations, or "guidance," for the December 2020 quarter with their third-quarter report; however, they had previously signaled that the fourth quarter would include a hefty $2.3 billion ($2.36 per share) restructuring charge.  This charge has to be included in the baseline for the results that comply with U.S. Generally Accepted Accounting Principles (GAAP), which are the kind I follow.

Another more positive factor that has to be considered when setting expectations is that the fourth quarter is typically the best one of the year for IBM.

The following baseline Income Statement takes into account what I know about IBM and its historical results, but I have less confidence in the figures than I normally might.  The extent to which the company can compete effectively against large cloud service providers is still to be determined, and COVID-19 only makes the outlook even murkier.  The earnings estimate is a loss of $88 million, minus $0.10 per share.

Please note that my organization of revenues, expenses, gains, and losses, which I use for all analyses, can and often does differ in material respects from company-used formats.  The standardization facilitates cross-company comparisons.

#ibm #lookahead #gauges #gcfr #gcfr2 #nac_financialanalysis

IBM: Gauge Analysis (updated November 9, 2020)

I have analyzed IBM's financial statements to determine whether the reported figures suggest that the company's shares are a good value and reasonable risk for prudent investors. The way I performed this analysis was inspired by Benjamin Graham's recommendations in "The Intelligent Investor," which was first published in 1949 and is still one of the best-known books about value investing. I modified Graham's specific suggestions to fit modern times; however, the goal is the same: find stocks that are inexpensive relative to the company's strengths and aren't excessively risky.

The analysis evaluates investment suitability by gauging how well the company satisfies seven criteria.  GREEN, YELLOW, and RED grades indicate whether each gauge is fully satisfied, partially satisfied, or not satisfied at all.  An Overall Score between zero and 100, which takes the details of all gauges into account, is also computed.  While the analysis includes both growth and value criteria, the calculation is weighted to favor companies that exhibit good value characteristics over firms that are fast growers but expensive.

An Overall Score of 60 or higher is a good result, and it signifies that the company has enough value-investment appeal to be worth examining in more detail. 

First, a quick review of the company itself.

IBM was the first giant computer company, and it was once one of the largest companies in the world.  When hardware became a commodity product, IBM increased its focus on more-profitable information technology services for businesses.  Always a research powerhouse, the company subsequently developed cloud-computing and artificial intelligence services (e.g., "Deep Blue"), but IBM's annual revenue has been slowly declining for years. IBM started to recreate itself in a more radical way in 2019 by acquiring Red Hat, a leading open-source software firm, for $34 billion.  The next step came when IBM announced in October 2020 it would spin off its managed infrastructure services unit, into a separate company.  This business is currently part of the Global Technology Services division, and it brings in revenue of about $19 billion per year.  

IBM recorded profits of $8 billion on revenue of $75 billion during the last year. In the quarter that ended on 30 September 2020, IBM earned $2.58 per share (excluding certain items), which matched the $2.58 Wall Street consensus forecast. See https://tinyurl.com/y34rev9g for IBM's most recent quarterly report.

Shares of IBM now trade for about $115 each.  These shares can be found in the Dow Jones Industrial Average, Standard and Poors 500, Standard and Poors 100, New York Stock Exchange Composite, and Russell 1000 stock indices.

Analysis Results:

IBM's grades on the seven investment criteria are listed below, along with some of the financial figures that influenced these color assignments

1. The Company's Size is Substantial: GREEN

    Market Value: $103.6 billion (mega-cap)

2. The Company is Conservatively Financed: RED

    Current ratio = 1.0 (>2.0 is conservative)

    Long-term debt/Working Capital = 2978% (<150% is conservative)

3. The Company Generates Stable Earnings: GREEN

    Nineteen positive quarterly earnings reports in last 5 years (almost perfect)

    Earnings variability = 12% (modest)

4. The Company Exhibits Earnings Growth: RED

    Owner Earnings growth rate (trailing year) = -5% (poor)

    Owner Earnings growth rate (five-year average) = -6% (poor)

    Free Cash Flow growth rate (trailing year) = 3% (weak)

    Free Cash Flow growth rate (five-year average) = -1% (poor)

5. The Company is Efficiently Profitable: GREEN

    Cash Flow Return On Invested Capital = 18% (good)

    Operating Profit/Sales = 11.4% (good)

6. The Company Pays a Healthy Dividend: GREEN

    Dividends paid for the last 7 years or longer

    Dividend 5-year average growth rate = 4.8% (weak)

    Dividend = 44% of last year's FCF (sustainable)

7. The Company's Shares are Fairly Valued: YELLOW

    Price/Owner Earnings (last year) = 10.0 (appealing)

    Price/GAAP Earnings (five-year average) = 12.0 (appealing)

    Free Cash Flow/Market Value = 12.8% (very appealing), more than the five-year average of 10.1%)

    Acquirer's Multiple = 17.9 (expensive)

    Price/Book Value = 4.9 (less expensive than the five-year average of 7.4)

    Price/Sales = 1.4 (less expensive than the five-year average of 1.7)

In summary, the analysis assigned IBM four GREEN, one YELLOW, and two RED grades.  The resulting Overall Score is 55 of the 100 possible points, which is a good, but not quite high enough result.  The score is below the 60-point threshold, and, therefore, IBM does not qualify at this time for consideration by value investors.

Check back here occasionally for updates to the Overall Score, which can change when the company releases new financial results and when there's a significant change in the company's share price.

This analysis reported here is not, by any means, a complete evaluation of the subject company, and it does not consider all material facts about the company's operations, finances, or future prospects. The analysis relies on publicly available financial data assumed, but not guaranteed, to be accurate. Readers are encouraged to independently verify all data. Other analytical approaches and screening criteria will be more applicable to investors having different goals, circumstances, and tolerance for investment risk.  The analysis is not and should not be considered investment advice, nor does it constitute an offer or solicitation to buy or sell any security. The author might have a long or short position in the subject company and/or its competitors. The methodology and results are subject to change without notification.

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 #ibm        #gauges  #gcfr  #gcfr2 #valueinvesting   #financialanalysis