For the first quarter of 2012, a recent check reveals 83 percent of companies are beating estimated earnings; some are beating by a wide margin.
With this great news, the markets seem to be at best holding onto most of their gains for 2012.
While this is a positive, some might anticipate a fall in stock prices. Many times this year, I have written that I don’t see why that would happen, and I encourage you to look past the macro negativity that may be preventing you from investing your money. Look at some of the great buys that are out there for you to pick up a piece of a great company.
Last week, IBM (NYSE: IBM) reported earnings. The first-quarter estimate for 2012 was an EPS of $2.65, which the company beat by nearly 5 percent, coming in at $2.78.
Many analysts increased their earnings going forward, and for the year ending December 2013 the estimated EPS is $16.61 per share. This estimate is up 14 cents from 90 days ago. Using a multiple of 20 would give an investor a target sell price of $332 per share. With the stock price around $205 per share, the forward PE is pretty good at 12.3. I get nervous when the forward PE hits 20.
Currently, Starbucks (Nasdaq: SBUX) has a forward PE of 26, and Chipotle Mexican Grill (NYSE: CMG) has a forward PE of 37. Both of these companies are expecting high growth going forward, yet IBM, with a five-year growth rate of 10.6 percent, can only command a FPE of just over 12? That’s strange. Maybe this is why Warren Buffett has added IBM to his portfolio.
Looking at current valuations for IBM, I see good and bad. On the good side, price to sales comes in at 2.2, well below the industry average of 2.9. The PE over the last 12 months is 14.9, also well below the industry average of 25. Price to cash flow looks OK at 11.1, compared to the industry average of 14.3.
What I don’t like, and a reason why I’m surprised that Buffett owns this stock, is that IBM has $27 billion of goodwill and $4 billion of intangible assets. IBM has equity of only $21 billion, and I say "only" because the intangible assets exceed the $21 billion of equity by $10 billion, which doesn't yield the strongest balance sheet. This was a no-no for Benjamin Graham, having a company with intangible assets exceeding the equity.
IBM does pay a dividend at a current rate of 1.7 percent, only using 22 percent of its earnings to pay that dividend. Over the last five years, that has grown at a 21 percent rate, so I would expect to see that dividend increase.
The sales growth for IBM could have been better, coming in at 5.3 percent year over year for the last 12 months, less than half the industry average of 13.9. Earnings per share growth looks better for IBM, coming in at 12.3 percent growth year over year for the last 12 months, which was far better than the industry average of 0.1 percent.
An important note with this company is the weak balance sheet. The current ratio is 1.3 — well below the industry average of 2.0. More worrisome is the debt to equity of 154.8, compared to the industry of 28.5.
I’m not sure what IBM is doing with its debt, but over the last 12 months it has risen to $32 billion from $30 billion. This was another no-no for Graham, having high excessive debt on the balance sheet.
Buffett, what are you thinking?
The problem is that if IBM has to write off any of those intangible assets, that will decrease the equity and increase the debt to equity, which is not a favorable position. As long as everything is going well, there are no problems. But if the economy or the tech sector or IBM has some problems, those intangible assets and high debt can destroy shareholder value quickly.
IBM does have a nice profit margin of 15 percent, which is far better than the industry average. The company does a great job when looking at its return on equity of 74 percent for the trailing 12 months and 60 percent for the five-year average. But include its debt and look at total return on capital, and the five-year drops to 18.7 percent, and the trailing 12 months drops to 21.5 percent.
I like seeing all the companies with earnings beating their estimates, but that doesn’t mean that they are great buys or great companies.
Wilsey is president of Wilsey Asset Management and can be heard every Saturday at 8 a.m. on KFMB AM760. Information is provided by Reuters.