Another Rally by IBM--Could This Be the Real Thing?

The Gang That Couldn’t Compute Straight--better known as IBM Corp.--suddenly is riding high on Wall Street again after a five-year stretch in the market hoosegow.

IBM’s share price has jumped from a 10-year low of $81.625 on April 3 to $97.125 at Thursday’s close, a 19% gain. The stock traded as high as $98.25 Thursday, marking a new 1992 high.

Since the computer giant peaked at $175.875 a share in 1987, its investors have suffered through one of the worst corporate identity crises ever visited on a major U.S. company. IBM became a symbol of all that was wrong with Big Business: lack of focus, soaring expenses, bloated staffing, falling profit margins and uninspired products.

Yet even as profit dwindled, IBM shares rallied repeatedly between 1987 and 1991--whenever investors decided that the company was on the verge of righting its wrongs. Unfortunately for the buyers, they were always too early. Last year wound up IBM’s worst ever: Sales dropped 6% to $64.8 billion, and the company posted a loss of $4.95 a share after one-time charges.

So why believe the latest rally is the start of something significant? Peter Labe, who runs Labe & Co., a stock research firm in New York, contends that the market is just now recognizing the “impeccable story” in the dramatic restructuring IBM engineered late last year.

Finally caving in to critics who said IBM had become too large and unwieldy a global operation, management in December decided to break the company into a number of “independent business units,” or IBUs, generally by product line.

Instead of the highly centralized IBM of old, Labe says, “management now says, ‘We have these divisions, and we’re going to ask each of them to commit to an 8% return on assets by 1994. And we’re also going to say that half of the compensation of the executives is dependent’ ” on reaching that.

By Labe’s calculations, an 8% return on assets would mean an 18% return on equity--i.e., 18% on shareholders’ investment. IBM hasn’t achieved that since 1985. In terms of earnings, Labe figures that an 18% ROE would translate into $13 a share by 1994. At $97.125 a share now, the stock’s price-to-earnings ratio on that ’94 earnings target is a mere 7.5.

Even if IBM doesn’t hit the target, progress in the interim is more likely than not to be rewarded by a higher share price, Labe figures. Analysts generally see IBM’s earnings rebounding to $7 a share this year and $9.50 a share next year. Earnings comparisons will be extremely easy over the next two quarters, because IBM earned just 20 cents a share in the second quarter of 1991, and 30 cents in the third.

Indeed, it’s more probable that the stock has been reacting lately to growing trust in the ’92 and ’93 earnings estimates than the ’94 goals.

The best news in the near term is that IBM’s new generation mainframe computer, the ES/9000, apparently is being well received by customers. What’s more, Standard & Poor’s Corp. analyst Lawrence Freitag argues that with a host of other new products across the spectrum of minicomputers, storage devices and workstations, “IBM is in its strongest position in over five years.”

The weak global economy and a new price war in personal computers remain concerns, of course. But what IBM can’t do for the bottom line in product sales this year, it may be able to make up through cost cutting, analysts say. The ongoing restructuring is expected to trim up to 20,000 of IBM’s 345,000 jobs this year. “Their controllable expenses are headed south,” says Marc Schulman, analyst at UBS Securities in New York.

Finally, there’s the dividend. The $4.84-a-share annual cash payment provides IBM owners with a yield of 5% at the current stock price. Brokers are having a field day pitching this to small investors: Why keep your cash in a 3.5% money fund when you can get 5% from IBM?

“This stock sells extremely well as a retail story because of the yield,” says Jay P. Stevens, analyst at Dean Witter Reynolds in New York.

With so much going in its favor, IBM looks like a winning stock for the rest of the year, Schulman says. Longer-term, he warns that a new generation of lower-cost computers from IBM’s many competitors could cripple the giant again by late 1993. IBM “is not going back to the good old days,” Schulman says. But for now, he adds, “We’re in a sunny interlude.”

IBM Comes Alive

IBM’s shares have rallied strongly since April, as more investors have bought the company’s rejuvenation story.

Weekly closes on NYSE, except latest

Thursday: $97.13