Value investing does not have to offer immediate value, or even immediate returns. Indeed, the best value investments are the ones that offer value, growth and returns for many years into the future. One of the best potential ‘future’ value investments around right now is International Business Machines Corp. (NYSE:IBM).
IBM offers long term value and returns
International Business Machines Corp. (NYSE:IBM) may not be your standard value investment but ‘big blue’ offers long term value and shareholder returns that are almost second to none. Not many people know, but IBM actually started life as a clock maker in the late 1800s; any company that has lasted that long in one form or another is well placed to last another century.
IBM switching from hardware to software
IBM has been showing its ability to move with the times over the past decade or so as the company has been switching from a hardware company, towards a software and services company. For example, back in 1994, 26 percent of IBM’s revenue came from the provision of IT services and 51 percent of revenue came from hardware sales. In 2004, this split had changed to 48 percent of revenue from services and 31 percent of hardware sales. In 2012, this split had changed once more to 57 percent services and 17 percent hardware.
This change in revenues has led to an expansion in margins, which have risen from 5 percent in 1994 to 16 percent in 2012, between 50 percent-60 percent of EBITDA has been converted to cash during the last five years.
While IBM’s ability to change with the times is important, another equally important factor is the company’s ability to create future for investors and this is something the International Business Machines Corp. (NYSE:IBM) excels at. During the period between 2008 and 2012, IBM returned on average 84 percent of net income per year to shareholders through both buybacks and dividends, equal to an annual cash return of 6.3 percent on average, per share, per year for investors.
Furthermore, IBM’s multi-billion dollar buyback programs have reduced the overall number of diluted shares in issue by 20 percent since 2008, which is partly the reason for IBM’s explosive 62 percent rise in fully diluted EPS over the past five years.
In addition, over the past ten years International Business Machines Corp. (NYSE:IBM)’s earnings per share have expanded a staggering 597 percent while revenue has only increased by 33 percent, highlighting the company’s overall ability to create shareholder value.
That said, International Business Machines Corp. (NYSE:IBM) is not a traditional value play. The company currently trades at a P/B ratio of 11, however, the firm does trade at TTM P/E of 12.9, which cheap for the tech sector and significantly below the S&P 500 market average.
IBM also looks expensive when compared to its own 5-year average historical ratios. In particular, on an EV/Revenue basis IBM looks to be overvalued by about 18 percent compared to its 5-year average of 1.92x, the company is currently trading at a EV/Revenue figure of 2.26. Additionally, EV/EBIT, which stands at 11.3 compared to its 5-year historical average of 10.4.
Strong history of creating value for investors
Still, all in all International Business Machines Corp. (NYSE:IBM) has a strong history of creating value for investors and I do not believe the company is going to damage this reputation any time soon. While International Business Machines Corp. (NYSE:IBM) is not a traditional value investment, the company’s long term investment thesis far outweighs the slight premium that the company is trading at compared to its historic valuation.
Overall, for long term value creation, IBM is a winner.