Yes, we are number freaks but when we see perfection we have to say bravo. We are knee deep in 4th quarter numbers when we stumbled on IBM. Man, they manage their balance sheet well. Let’s get into it.
Under ‘Key Concepts” we have a box called “Theoretical Earnings” (TE), where we explain the concept and how we believe the market observes this differential between a company’s earnings and TE. We can also say, the equity market gives valuation upside not only because of this differential but also a premium valuation to companies that are increasing this differential on a dynamic basis. If the spread is increasing, between earnings and TE, the market will value this company higher certainly over the company where this dynamic is stalled or worse falling.
Let’s turn to IBM’s numbers. In Chart 1 below, we graph each the 12-month forecast earnings per share and theoretical earnings going back to 1989. For the financial historians, one can see why IBM fell on tough times in 1992 to 1994. As one can see earnings fell below TE causing the market to lose confidence in the company and management.
Chart 1
In Chart 2 below, we made a differential graph highlighting the difference between 12-month forecast earnings and theoretical earnings including data up to December 31, 2011. IBM is close to making 4x their TE, which is close to surpassing there all time high of 4.5x during the technology boom of 2000. Considering they are achieving this in today’s not – so – great economic environment is impressive.
Chart 2
So here is the question. How does IBM, which has TE of $3.97, as of December 31,2011, keep their theoretical earnings so low? Keep in mind they will earn $15 per share in 2012. In 2011, “they returned $18.5 billion to shareholders” – their language, $3.5 billion in dividends and bought back almost 89 million shares for $15 billion. These people know how much cash to use so their balance sheet doesn’t get too big, and still have cash in their business for operating purposes, as the company gets bigger. Yes, I will say it again impressive.
Unfortunately, IBM trading at a premium to our calculated model price of $140.45, (as of January 24,2012). We can only hope Europe blows up, or if we get another shock in the market this company deserves to be on someone’s wish list.
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Model Price 