International Business Machines Corp. (NYSE:IBM) disappointed the investment community on October 16th when the company announced its results for the third quarter. Revenue at IBM fell 5% from the third quarter of 2011, but costs were cut sufficiently to bring earnings about even with its performance at that time. With share count coming in lower, earnings per share increased to $3.33 for the quarter. What investors focused on, however, was that once again IBM had failed to meet expectations on the top line and the stock price fell 3-4% in after hours trading.
International Business Machines Corp. had been trading at 15 times trailing earnings, and with earnings per share up and the stock price down that figure has tilted down slightly. It looks to us that its forward P/E is only 12. True, it’s not good to see revenue declining, but IBM has a number of attractive characteristics as well: it has a large market capitalization of about $230 billion, it appears to be making progress in its transition from a hardware to a software and services company, and with a beta of 0.6 it has little sensitivity to the broader market.
We’re interested in seeing if Warren Buffett is disappointed with IBM’s results. At the end of June, Berkshire Hathaway owned 67 million shares of International Business Machines Corp., up 3% from the beginning of April and making the company one of the three largest positions in Berkshire’s 13F portfolio (see more of Warren Buffett’s favorite stocks). Billionaire Ken Fisher’s Fisher Asset Management also slightly increased the size of its position, and at the end of the second quarter owned 2.2 million shares (find more stocks that billionaire Ken Fisher likes). D.E. Shaw, a large hedge fund founded in 1988 by now-billionaire David E. Shaw, increased its own stake by 22% to a total of 2.1 million shares (research more stocks D.E. Shaw was buying).
We would compare IBM to Hewlett-Packard Company (NYSE:HPQ) and Dell Inc. (NASDAQ:DELL) in terms of combining hardware sales with a move towards software and services. These two companies haven’t been doing as well as IBM: HP is actually unprofitable, and Dell experienced an 18% decline in earnings in its second fiscal quarter compared to the same period last year. Even on a forward basis, with HP expected to achieve positive earnings, the market is extremely skeptical: HP and Dell trade at 4 and 6 times forward earnings estimates, respectively. Their dividend yields are also worth considering, at close to 3.5% in both cases. We’re certainly wary of these companies, and we don’t trust analyst expectations in the case of HP, but we’re also not sure they should be trading at such a discount to IBM.
Microsoft Corporation (NASDAQ:MSFT) and Accenture Plc (NYSE:ACN) are two other large-cap technology software and services peers for IBM. Microsoft’s trailing and forward earnings are both a bit skewed as the former includes a large writeoff and the latter likely includes a sugar high from the release of new versions of Windows and Office. The forward P/E is 9, however, and even after adjusting for these sales it is likely still cheaper than IBM. Its revenue is up and it pays a 3.2% dividend yield. We’d like to see the company actually deliver profitability on its parade of new products, but there is a good value case for the stock. Accenture’s business was about flat last quarter compared to the same period a year earlier, with revenue and earnings both within 6% of what it reported at that time. It carries the highest trailing P/E multiple of any of these companies, at 18, and we don’t think its recent performance shows enough growth potential to justify that multiple. As a result we’d avoid that stock.
We don’t think IBM’s news has been quite so bad; the revenue decline is certainly not a plus, but the company is holding the line on earnings for now. However, diligence on Dell in particular could be helpful to see if it can meet analyst targets for next year, and Microsoft also looks like it might be more attractive on a value basis.