Party with IBM like it's 1999
Analysts say shares could hit their highest level since the turn of the century.
SAN FRANCISCO (Fortune) -- If you own IBM shares, hold 'em. If you don't, now might still be a good time to get a piece of Big Blue.
Like many tech stocks, IBM (IBM, Fortune 500) has been on a tear lately, up almost 41% since March 9 lows. But even though its shares are knocking on the door of 52-week highs, they still lag the blistering 64% increase overall of the Nasdaq (COMP) and, perhaps more important, the 56% rise of the S&P 500 (SPX) during the same period.
Over the past five years IBM has traded at an average P/E ratio that is about 10% lower than the S&P 500's, according to financial data firm FactSet. With a current P/E just north of 12, IBM now trades at about a 25% discount to the S&P 500. So if IBM reverts to more typical ratios, it has some room to rise.
How much? Barclays Capital analyst Ben Reitzes recently raised his price target on IBM to $140 (that would eclipse the record high of $138 set in 1999). Reitzes sees IBM benefiting from continued strength in its core software and services businesses, but he highlights the long-awaited return of corporate spending on hardware in 2010.
While it accounts for only about 17% of sales, IBM's hardware business has been the hardest hit during the recession, down 12% in the third quarter (margins fell slightly too). IBM has been beating Street estimates on earnings by cutting costs and wringing more margin out of its software and services businesses. Those sectors clearly dominate IBM, but all of IBM tends to do well when its hardware business is on a roll.
That hasn't happened yet. In the third quarter IBM yet again beat analysts' estimate for earnings, posting a 14% increase in net income year-over-year. Revenue, however, fell 7% during the same period (the decline was much smaller than in the previous quarter).
IBM didn't show the top-line growth that investors are looking for, in part because of the continued hit its hardware business is taking. Without evidence of a return to revenue growth, IBM shares were punished the day after its third-quarter earnings were announced, dropping 4%.
But the next six months are likely to offer a rosier picture, says Mark Loughridge, IBM's CFO. Loughridge predicts a return to revenue growth in the fourth quarter, driven by improved performance in both its software and hardware business.
"We're not just saying we see an improvement in profitability for our hardware business going from third quarter to fourth quarter," Loughridge told analysts. "We're looking at it and saying that the hardware business ought to be growing profitability at double-digits as we go into the fourth."
Remember, all of IBM does well when its hardware business is humming. So if you start to see an uptick in sales of servers, storage systems, and mainframe computers, you're also likely to see continued upside for Big Blue.