On the 14th, 15th, and 16th of February, 2011, a contestant named Watson appeared on the long-running game show Jeopardy! The contestant did pretty well, effectively winning the three-day challenge, particularly considering that it was up against some of the best former contestants in Jeopardy! history. The use of the term “it” in the previous sentence wasn’t a typo. Watson is a computer.
Although a computer can easily house more information than a human mind, the problem isn’t storage—it’s retrieval. Getting the information out of a computer is the hard part because you have to know what you are looking for. So, building a computer that can actually answer questions “just like a human being” is an incredible feat. This is even more the case when you consider that many of the Jeopardy! questions are contextual and often have a nuance that extends well beyond the yes and no answers that computers are so good at providing.
Watson is, simply put, a marvel of artificial intelligence, demonstrating the advances that have been made since a computer nicknamed “Deep Blue” took on chess champion Garry Kasparov in 1997—and won.
In early April, 2011, a new nanomedicine breakthrough was discovered that could someday help in the fight against antibiotic resistant bacteria. These difficult-to-fight bacteria have lived for years in hospitals, but have increasingly begun to migrate out to the general population. Being resistant to current medical treatments causes serious problems, as the bacteria, and other diseases, ravage a victim’s body, while medical practitioners are virtually helpless bystanders.
The nanomedicine involves new types of polymers that appear capable of physically detecting and destroying the drug resistant bacteria and infectious diseases, while leaving other cells unharmed. If this technology can be brought to market, it could forever alter the way in which patients are treated. Moreover, if the technology can be adapted to target other types of illnesses, such as cancer or HIV, it could revolutionize medicine as it is known today.
The common theme between Watson and the nanomedicine discover is International Business Machines (IBM – Free Value Line report on IBM). In fact, the list of interesting, though often divergent, discoveries and advances that have come out of IBM could take up an entire book. This technologically advanced face, however, isn’t the one that most people think of when they imagine the company that has been dubbed “Big Blue”.
Many still think of the company as a computer maker (some might even remember it as a typewriter manufacturer), but it is much more than that today. For starters, as the Business Description highlights, the company’s Systems and Technology division only accounted for 18% of revenues in 2010. Services, meanwhile, made up over 50% of revenues. (The remainder is made up of Software, 23% of revenues, and financing operations.) Clearly, Big Blue is not just a computer maker anymore—it’s branched off into services in a big way.
This shift has helped drive the company’s top and bottom lines of late, with trailing annualized five-year growth rates of 6.5% for revenues and 16% for earnings. Note that the earnings growth rate was more than double the revenue growth rate, which is a sign of excellent managerial execution. These growth rates can be found in the Annual Rates box on the Value Line report, along with the impressive trailing annualized 10-year growth rates of 5% for revenues and 10.5% for earnings.
Note, that a company as large as IBM simply can’t increase revenues as quickly as a smaller technology company. However, while a smaller technology concern might be able to show 20% revenue growth, that growth might come at the expense of earnings—which are often negative for smaller technology companies in their early growth stages. Moreover, IBM earns Value Line’s highest possible Safety rank of 1, something few technology companies can boast because of their volatility.
Value Line’s proprietary Safety Rank, which can be found in the Rankings box at the top left of every report, is a combination of its Financial Strength rating and Stock Price Stability scores—both of which can be found in the Ratings box at the lower right of a Value Line report. An A++ Financial Strength rating (the highest possible) and a 95 Stock Price Stability score (100 is the best possible score) underpin IBM’s Safety Rank. The stock’s Beta, a measure of volatility relative to a broader index, is also below average at 0.85, suggesting that it will move up and down less than the broader market. As far as high-tech companies go, IBM is clearly as stable as they come.
While some might be concerned by a capital structure that is nearly 50% debt, a fact shown in the Capital Structure box, IBM clearly has the wherewithal to handle the burden, as noted by the fact that earnings cover interest charges 20 times over. This gives the company ample room to increase its business and continue to invest in its research. Note, too, as Value Line analyst Theresa Brophy highlights in the Analyst Comment, that the majority of the debt on the balance sheets supports the company’s financing operations, leaving the rest of the company with about $5.5 billion in debt.
This is a good thing, because IBM spent about almost $6 billion dollars on research and development in 2010 (this “back of the envelope” number can be calculated by multiplying the company’s 2010 revenues of $99,870,000,000, found in the historical portion of the Statistical Array, by the R&D spending percentage of 6% found in the Business Description box.) That’s a big number that few companies can match. It also helps explain why Big Blue’s tentacles stretch so far beyond just one industry or area of expertise. In fact, the company has identified four strategic areas of focus; growth markets (developing economies), cloud computing, business analytics, and what IBM has dubbed smarter planet (using “digital intelligence” to improve any number of processes and functions). Management expects these areas to drive $20 billion in incremental revenue over the next three to five years.
Having met and exceeded previous guidance of this nature, there doesn’t appear to be any reason to doubt IBM’s ability to reach this goal. Indeed, a strong financial backbone, massive spending on R&D, and a dedicated management team, appear to position IBM for solid long-term growth over the next three to five years. Moreover, the company’s recent financial performance and share price action also earn the stock Value Line’s highest rank for Timeliness, meaning that the shares are likely to outperform the broader market over the next six to 12 months, too. Despite a solid advance from its 2008 low of about $70 a share, now could very well be a good time to buy stock in Big Blue.
At the time of this article's writing, the author did not have positions in any of the companies mentioned.