Why IBM attracts value investors
Despite growth prospects that surpass those of the S&P 500, IBM trades at a 15 percent discount to the market.
NEW YORK (MONEY) -- IBM remains one of the world's greatest technology companies, but the stock has been stagnant for more than a year.
To some extent, this is understandable: A number of short-term problems are hanging over Big Blue.
Nonetheless, the company has impressive long-term strengths, suggesting that its earnings should outpace those of the typical large cap over the next few years. What's surprising is that the current share price trades at a price/earnings ratio that is 15 percent below that of the broad market.
The short-term negatives are easy enough to understand. For starters, technology stocks are generally depressed.
Further, the most promising part of IBM's business, computer services, is currently experiencing flat demand. As a result, analysts say second-quarter results may be disappointing. Those results are scheduled to be reported on July 18.
Look beyond the current quarter's number, however, and IBM is a much more appealing stock.
The company remains a powerhouse in the computer industry. Its machines account for nearly half of the world's supercomputers. And last month, an experimental IBM semiconductor broke the speed record for silicon-based chips.
IBM's computer services division also remains among the world's leaders. Demand for computer services and consulting is projected to pick up over the next two years, particularly overseas.
For that reason, IBM has been focused on expanding overseas. On Monday, for instance, IBM announced a 10-year contract to manage proprietary software for the German insurer AMB Generali.
More important from a long-term perspective is IBM's expansion in India, a source of enormous programming capability at relatively cheap prices. The company plans to invest $6 billion in India over the next three years.
Such expansion is easy for IBM to finance, since the company had $12.3 billion in cash on hand at the end of the first quarter. And that was after using $2.5 billion to repurchase stock during the quarter.
Altogether, analysts project that IBM's earnings can grow at a compound annual rate of around 11 percent over the next five years. That's slightly above the projected rate for the S&P 500. Big Blue's stock also yields 1.6 percent.
Given the near-term negatives that IBM faces, it would be understandable if the stock were trading at a P/E of 15 or 16, close to that of the S&P 500.
But IBM's P/E based on estimated earnings for the current year is only 13 -- and just over 12 based on next year's projected results.
That's much too low if you believe the company's long-term strengths will eventually shine through. The essence of value investing consists of buying fundamentally strong stocks when they are being ignored. IBM seems like a perfect case in point.
Michael Sivy is an editor-at-large for MONEY Magazine. Sivy on Stocks runs each Tuesday at CNNMoney.com -- sign up to receive it by e-mail.