Some investors don't like the notion of companies buying back their own stock, regardless of the circumstances, whereas others love the concept. I've always taken a middle of the road stance on the topic: I think there's a right time, and a wrong time, for businesses with large cash hoards -- like IBM (NYSE: IBM) -- to pare down the number of shares outstanding.
For example, initiating a share repurchase program can be an effective way to send investors a signal that even if a company's stock is under pressure in the near term, management has confidence that it will be able to right the ship.
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The question now at IBM is: Is the tech giant's use of ready cash for stock repurchases a sound, long-term move or a strategic mistake?
All the way, or no way at all
Share buybacks have been the norm at IBM for years. It has repurchased nearly $50 billion worth of its own stock over the past five years, including $3.67 billion so far in 2017. For some perspective, it spent $2.63 billion on its stock in the first nine months of last year.
For IBM, buying shares back this year has been a good move, and here's why:
As it continues its transformation away from legacy hardware solutions and toward its "strategic imperatives" businesses -- which include the cloud, cognitive computing, mobile, and data security, as well as blockchain, and other cutting-edge markets -- its stock prices has meandered. Even factoring in the recent spike that followed IBM's third-quarter earnings release, its performance has been unimpressive.
For the past five years, IBM stock is down 17% -- not exactly dire over a five-year period, but certainly, nothing to cheer, either. To the company's credit, the trend for the past month has been positive, with shares climbing 10%, but sustaining those good feelings will be a challenge.
The reason IBM's stock performance is such a key factor in answering the question of whether its buyback strategy makes sense is the same reason value investors should give the stock a close look. The old maxim "buy low, sell high" is simplistic, but there's an underlying truth to it. IBM stock has been, and remains, a relative bargain, trading at a mere 13.5 times trailing earnings, less than half its peer average of 28.8.
If CEO Ginni Rometty and her team can maintain the growth momentum in the strategic imperatives units, IBM could prove to be a long-term steal for value investors. And based on a number of shares bought back in 2017, Rometty certainly thinks IBM will get things turned around.
One of the few tech players that can boast a higher annual revenue run-rate than IBM in the cloud is longtime competitor and sometime partner Microsoft (NASDAQ: MSFT). At $18.9 billion the past 12 months, Microsoft is one of leading cloud providers on the planet. But with a $15.8 billion annual run-rate of its own, IBM is nipping at Microsoft's heels.
The good news for IBM and Microsoft -- and why they're among the leaders in this fast-growing space -- is that both have focused their growth initiatives in this arena on suites of software-as-a-service (SaaS) solutions delivered via the cloud. That's where the real opportunity lies, and if current estimates about the growth curve for that market are anywhere close to accurate, there's more than enough room for both IBM and Microsoft to excel.
Skeptics may point to IBM's $41.2 billion in long-term debt as an indication of a less-than-stellar balance sheet. However, in today's borrower-friendly interest rate environment, IBM is hardly alone in taking advantage of low-cost funds. Not to mention, IBM offset some of its long-term debt by shaving over $3 billion off its short-term obligations.
The upside is that between cash and marketable securities, IBM boasted $11.5 billion on its balance sheet last quarter, so there's little chance its repurchase program will threaten its financial stability. Factor in its still-depressed stock price, and last quarter's strategic imperatives growth, and it looks like Rometty is right to continue IBM's ongoing bets on itself.
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Teresa Kersten is an employee of LinkedIn and is a member of The Motley Fool's board of directors. LinkedIn is owned by Microsoft. Tim Brugger has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.