IBM Undervalued At Its Current Price

IBM has reported 13 straight quarterly decline in revenues and its earnings for the second quarter fell by 17%. Legendary investor Warren Buffett owns around 79.58 million shares of IBM, valued at $17 billion dollars. Mr. Buffet's Berkshire Hathaway (BRK.A),(BRK.B) is the largest shareholder in IBM owning more than 20 million than the second largest holders. Warren Buffett added to his position during the first quarter and now he is sitting on a quotation loss of $700 million.
Mr. Buffett isn't going to sell his stake in IBM, and I'm almost a 100% sure that he'll probably add to his position at its current price of $160 per share. IBM is currently having short-term problems which will be worked out over the next five to ten years. The company's estimated business value on a per share value will be higher than it's today.

Warren Buffett did an interview with CNBC back in May where he discussed why he bought more IBM shares. He believed that in ten years from now IBM will be earning more than they are now and will have fewer shares outstanding. Warren believes Berkshire will make a conservable amount of money on its investment in IBM over the next ten years. I agree with Mr. Buffett that IBM is a great value play that is offering investors pretax return of 16% that is double the current yield on a 10 year US Treasury bond.

The IBM's share price falling is a blessing for long-term savvy investors who can now add to their positions or acquire a position in IBM at a  31% from estimated business value. IBM is now selling for around 10x its next year earnings and around 13x last year's earnings. Since 2010, IBM has reduced its share count around 20 percent. This has increased its earnings per share. The company during this same period has been reporting declining revenues, and sales have been flat since the first quarter of 2012. Thanks to financial engineering IBM has been able to increase its earnings per share while sales and revenues have fallen or been flat. So Warren is correct, the company in 10 years will be earning more and will have fewer shares outstanding.

At its current price IBM is a buy offering a potential pretax return of 16% and selling for around 8.5x pretax earnings. If IBM sold for 10x its pretax earnings then the company would sell for $197.50 per share. The company has a Greenblatt earning yield of 10%, a forward rate of return of 12% and a pretax return of 16%. When you compare IBM's earning yield, forward rate of return and pretax return to the ten year treasury, you are to get twice the return on IBM then you will get investing in 10 year treasuries. Over the last ten years the company return on equity has averaged 58%, and its return on invested capital has averaged 29%. Over the next ten years IBM will continue to reduce its share count through buyback which will lead to increasing earnings per share. Earnings per share for IBM over the last ten years grew at around 14%. I believe the company's earnings per share will grow at around 14% over the next 10 years due to the company reducing its share count by 20% and will have a buyback program in place.

By using discount cash flow you can get the value of the company by using a 12, 15, and 17% discount rate to give use a range of estimated business value for IBM. At these discount rates the company is offering a range of margins of safety from 47% to 22%.Based on discount cash flow the company at its current price is selling less than its estimated business value, and is offering investors at least a return of over 10%. The value range for IBM based on its current pretax earnings and operating earnings is $176.10 to $196 per share. Based on discount cash flow the value range for IBM is $207.85 to $308.07 per share. IBM estimated business value is around $176 to $207 per share and offering investors over 20% discount.
By Cody Eustice
Cody is a freelance writer who has been writing financial articles for various sites for over a year now. He is a value investor looking for companies that sell for far less than their estimated business value.

Copyrighted 2016. Content published with author's permission.

Posted in ...