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This World Dominator Is Still One of the Best Investments You Can Make

By Dan Ferris, editor, Extreme Value
Friday, May 1, 2015

Last November, I told DailyWealth readers why World Dominator IBM was still a "buy" despite recent weakness in share price and earnings.
 
Since that letter, IBM has gained about 7%. Not bad. That's about twice the return of the S&P 500 in the same time frame. But for patient, long-term investors, I believe IBM is still one of the best opportunities in the market today.
 
Here's why...
 
IBM has a legacy of reinvention and transformation likely unequaled by any tech company on the planet. That legacy shows up in both where the business is today and where it's headed in the near future...
 
Today, IBM is the No. 1 IT-services company in the world. CEO Ginni Rometty quickly described IBM's dominant, critical position in world commerce in her recent annual letter to IBM shareholders:
 
We work with 90 percent of the world's top banks, 9 of the top 10 oil and gas companies, 40 of the top 50 retailers, and 92 of the top 100 health care organizations. IBM systems manage banking, reservations, transportation, retail, trading, and health care systems. Our mainframes alone process 75 percent of the world's business data.

IBM is also the No. 2 software company in the world, next to Microsoft. For example, IBM dominates the market for "middleware," the glue that holds other software programs together. Middleware operates behind the scenes, between the operating system and the user interface, performing functions like speech-and-gesture recognition.
 
IBM reported last Friday that it had a 29.1% middleware market share in 2014, according to a Gartner special report titled, "Market Share: All Software Markets, Worldwide, 2014." (The 12-page report costs $9,995 from www.gartner.com. This report is meant to be purchased by companies, not individuals.)
 
IBM's share is more than double the No. 2 competitor, Oracle (13.8%), and six times the No. 3 competitor, Microsoft (4.9%). It has maintained this dominance for 14 years in a row.
 
Dominating markets is a good thing, but the essential IT services Rometty lists above aren't growing like they once did. So IBM is investing in five faster-growing "strategic imperatives": data, cloud, social, mobile, and security.
 
By 2018, IBM expects those five areas to generate 40% of its revenue, up from 27% last year and just 15% in 2011.
 
Remember, major business transformations don't happen overnight, even for companies a fraction of IBM's size. And they never happen fast enough to satisfy Wall Street's quarterly-earnings-obsessed analysts, hedge-fund investors with axes to grind, and other know-nothing investors who can't distinguish a cash-gushing business from a cash-burning one.
 
IBM leads cloud services, too. IBM did $7.7 billion in trailing 12-month cloud products and services. That's up 75% over the previous 12 months. It's also more than Amazon and Microsoft. Some say IBM is late to the "cloud party." Amazon might have been there first, but according to revenues, IBM leads the field.
 
Last week, the company reported first-quarter 2015 results and noted revenue from its five strategic imperatives is up 30% year-over-year. Quarter to quarter, management expects these emerging businesses to keep improving.
 
If the transformation plays out as management expects, Wall Street analysts will upgrade IBM in their research reports. That could make mutual funds and other large institutional investors want to own the stock, likely pushing its share price higher.
 
So far, so good, as IBM trades about 15% off its 52-week low. We'll see where it winds up in the next couple years. We're in no hurry with IBM. Being in a hurry would reduce our odds of success by making us like everyone else.
 
Building new, strong, enterprise-class franchises in emerging fields takes time and money. IBM's slower-growth legacy franchises continue to gush big, recurring, annuity-like revenues, which it can reinvest in the five faster-growing strategic imperatives.
 
Meanwhile, the number of shares outstanding continues to decline (5% year-over-year in the first quarter) and the dividend continues to rise (up 16% year-over-year).
 
IBM is a cash-gushing World Dominator in a controversial period of transformation. Right now, it trades for less than 13 times expected 2015 free cash flow. That's cheap for a cash-gusher like IBM. If people knew it was in fantastic shape, you couldn't buy it cheaply. But bad news is good for patient, long-term investors in cash-gushing businesses like IBM. Our advice remains the same as it was in November.
 
Good investing,
 
Dan Ferris




Further Reading:

Many folks may think IBM is too "boring." But according to Dan, this thinking is a BIG mistake. "Boring is good for investors," he writes. "I mean... think of what excitement really is. Excitement usually means risk and trouble." Learn more about why he loves World Dominators in this classic interview.
 
Right now, Dan likes one sector of the market more than any other. "Investors who can look past the bad news today and single out great resource businesses selling at great prices have an incredible opportunity to make a lot of money over the next few years," he writes. Learn why here.

Market Notes


CHINESE STOCKS ARE STILL BOOMING

Today's chart takes another look at the soaring bull market in Chinese stocks.
 
Over the past few months, we've been telling you about the big opportunity in Chinese stocks. Back in November, Steve Sjuggerud even called it "the best market for 100% gains right now." A great way to see this boom in action is to look at the share price of NetEase (NTES)...
 
NetEase is China's leading Internet technology company. Valued at $16 billion, it's one of China's largest Internet service providers... and also operates China's largest online gaming network. According to Alexa's Internet rankings, NetEase's 163.com is the 64th most-visited website in the world – beating out the likes of ESPN and CNN.
 
As you can see below, NetEase shares are booming along with China. In the past year alone, shares have gone from less than $70 to more than $125 – a gain of more than 85%. Just yesterday, shares set another new all-time high. The boom in Chinese stocks is still on.
 

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