Volatility continues to hound investors even after Janet Yellen has tried to calm Wall Street’s fears about an early hike in interest rates. So it’s likely investors will stay a bit defensive and focus on price stability through companies with high earnings quality that sport lower betas.
In particular, the search will be not only for stocks with dependable financials but also for those that haven’t already been climbing to new price highs. And with the Dow Industrials and S&P 500 already touching new all-time high levels in recent weeks, finding such stocks won’t be an easy task.
One such name that some investors and analysts have "rediscovered" in recent weeks is International Business Machines (IBM), one of the few large-cap stocks that have yet to catch up with the market and the fast-moving stocks in the tech sector.
True, the stock has disappointed Wall Street as it struggles with its turnaround efforts. But while a number of analysts remain neutral on the stock, some fresh optimism has surfaced about IBM.
One specific example is S&P Capital IQ's addition of IBM to its 15-stock “High Quality Capital Appreciation” portfolio, replacing Qualcomm (QCOM). The stocks in this portfolio have super credit rankings of A minus or higher, and have maintained above-average earnings and dividend growth in the past 10 years. They also carry buy ratings from the S&P analysts.
IBM’s continues to enjoy a credit ranking of A plus, with strong financials to support a high dividend payout. “We expect continued share repurchases and see its 2.9% dividend yield as very appealing,” says Todd Rosenbluth of S&P Capital IQ, who supervises the top-performing High Quality Capital Appreciation portfolio. IBM is among the tech stocks that S&P Capital IQ rates as a buy, with a 12-month price target of $175 a share.
IBM has been moving higher in recent weeks, to $161 a share from a 52-week low of $149.52. Still, the stock is way below its 52-week high of $199.20 a share, which in truth spells more upside potential for the stock that's now on a recovery mode, and notably is one of the few low-volatile stocks in the tech group. Some big investors believe the stock will snap back to its old high near $200 in a year.
“Notwithstanding a lack of revenue growth, we think IBM’s cost reduction efforts, including workforce realignment efforts and productivity gains, should aid 2015 and 2016 earnings growth and margins,” says Rosenbluth. IBM’s growth opportunities, he adds, include advances in cloud and analytics, as well as in mobile.
As several Street followers of IBM started backing away from the stock late last year, switching their recommendations from a buy to sell or “neutral,” Scott Kessler, analyst at S&P Capital IQ, turned positive early in January 2015 and upgraded the stock to a buy from a “hold” after the company reported fourth-quarter results.
Kessler noted that the company’s diverse business model offers appeal even as it faces continuing challenges while adjusting its portfolio of offerings. An example is IBM’s direct investment through its $100 million fund to seed Watson innovations, including “Modernizing Medicine” to accelerate adoption of Watson Technologies in healthcare. The cloud-based system analyzes high volumes of data and questions and proposes evidence-based answers.
IBM, which remains the world’s largest information technology company with over 300,000 employees, will continue to invest $4 billion in strategic growth areas, notes David M Grossman, analyst at investment firm Stifel, who recommends the stock as a buy with a price target of $180 a share. Concern that IBM is under-investing in its business to drive margin is “misguided,” he asserts. The company invests over $5 billion a year on R&D alone and spends about $3 billion a year on acquisitions. Excluding services and global finance, that R&D spending equates to 25% of revenue, says Grossman.
The analyst sees IBM earning $17 a share in 2016, up from an estimated $16 in 2015. The IT landscape is evolving at a rapid pace, says Grossman, and IBM is positioning itself as the key partner in the enterprise ecosystem, emphasizing scale, global reach, security, analytics and reliability. It’s providing critical conduit for vendors that want access to this market, such as Apple (AAPL) in mobility and Twitter (TWTR) in social/analytics, he notes.
The new message from IBM is the “clearest and most reasonable in several years,” notes Kathy L. Huberty, analyst at Morgan Stanley, providing analysts with greater financial transparency on its strategic imperatives. However, over the near term the company faces certain challenges that would limit the upside pressure. She advises in a note to clients that as the headwinds fade into 2016, “we see the potential for investors to shift focus to the more attractive long-term outlook,” says Huberty, who maintains an equal-weight rating on IBM’s stock.
No doubt the Street remains wary about IBM’s forward push, as efforts to improve margins will continue to weigh on revenue growth over the near term. But the company’s key themes remain consist and more constructive than in the past few years, notes Stifel analyst Grossman. And surely, any surprises from here will be on the upside – even in this volatile market.
