IBM: Better Than HP

by Doug Ehrman

Several big technology companies released earnings news this week, including IBM (IBM), Intel (INTC), Microsoft (MSFT) and Google (GOOG). While none of the results were awe-inspiring, the general sentiment amongst investors is that nothing released was sufficiently catastrophic to spell imminent doom – sometimes an indication that a company will survive to fight another day is enough. With the exception of Google, none of the above companies could be called “sexy” in the investment sense of the word. Yet these perennial performers are members of the Dow Jones Industrial Average, have demonstrated the long-term ability to operate effectively and each have the ability to be a part of a significant breakthrough that may return that company to a lucrative growth phase.

Another name that could easily be included in the above list is Hewlett-Packard (HPQ). Despite its share of ups and downs, the company has been a long-time member of many core technology portfolios. Recently, however, Jim Chanos, the manager of the Kynikos hedge fund, publicly stated his intention to short the stock. He referred to the stock as a “value trap,” meaning that despite the company’s depressed valuation, the company was a poor investment – essentially, the low valuation was a trap for investors looking to buy the stock near its 52-week low. To put the comment in perspective consider that the stock is trading in the mid – $18 range, just above the 52-week low of $18 and has a trailing twelve month price-to-earnings (P/E) ratio of 7.1 relative to 13.9 for IBM, 10.7 for Intel, 14.6 for Microsoft and 18.3 for Google. If one were basing his or her investment decision purely on valuation, one might decide Hewlett-Packard was the best choice. Based on this level of public criticism, backed by the kind of investment dollar that Mr. Chanos can bring to bear, pausing, if not passing, on Hewlett-Packard is likely advisable.

This should not be interpreted as an endorsement of Mr. Chanos’s plan to short the stock. It is impossible to know where the call fits into his overall portfolio or strategy. Furthermore, the risk appetite and diversification control available to a hedge fund manager is not accessible to most retail investors. While Mr. Chanos may be proven right in his call on the stock, this is a high-risk bet being made by a professional and is not appropriate for an investor who is not similarly situated.

Why Is IBM in a Better Spot?

Where IBM lacks the flash and flare of Apple (AAPL) or even Google, the company is known as a corporate technology specialist that offers nearly unrivaled solutions for its clients. The company is not in the business of making a few bucks per unit by selling the most popular gadgets on the market, the company is in the business of providing rock-solid technology solutions to companies that want tech than works without question and offers unilateral support when there is a problem.

Additionally, IBM continues to find ways to innovate and quietly lead its field. Over the last three decades, the company has spent over $150 billion on research and development which has yielded more than 75,000 patents. Think it is slowing down? In 2011, the company was awarded more patents than any other company in the U.S. or abroad. With a long tradition of turning innovation is to saleable products, IBM is well situation. Where a consumer will only upgrade his or her tech at regular intervals because of income constraints, enterprise customers have a near continuous need for progress. Improved efficiency leads to lower costs and higher profits, so the process rarely slows. Furthermore, as more and more basic tasks can be replace human intervention with automated processes, not only will IBM’s product base grow, its costs should continue to shrink.

A Quick Look at Earnings

While the numbers that IBM reported were not spectacular, there were some critical elements worth careful consideration. For example, the company was able to improve operating earnings per share by fourteen percent. The significant bulk of these improved profit margins came from the service piece of the business. Company officials stated on the earnings call that an integral goal for the future is to successfully pair IBM scientists with service teams; the hope is that they can collectively improve efficiency. Ultimately, the improved margins following from the corporate strategy bodes well for the long-term prospects of the company and the stock.

IBM Over Hewlett-Packard

Working from the premise that every investor should maintain an allocation to large technology companies, benefiting as they lumber along paying dividends and quietly carrying the way, IBM is a far better option than Hewlett-Packard. Where IBM has a clear corporate identity that leads it to an enterprise business showing no signs of slowing, Hewlett-Packard seems to be suffering from a multi-year identity crisis. IBM continues to innovate and find new business lines to leverage into new earnings – the services business at present. Hewlett-Packard, on the other hand, is squarely positioned with core products – printers and personal computers – that are hurtling towards obsolescence. For someone who can remember life before a computer in every home, let alone in one’s pocket, the idea that the PC may come to the end of its dominance is difficult. However, this is clear direction of the industry. IBM is well positioned to provide long-term value to shareholders and Hewlett-Packard is not. For these reasons, IBM should be one’s preference as a core large technology holding.