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Thursday, December 23, 2010

Cramer's take on IBM

Last night I noticed Cramer's bottom's-up approach to the Dow reaching 13,000. I agree with a lot of it.

He of course mentions IBM, and the one thing I just wanted to point out was that his eps-growth-est-to-PE does not make sense. He states:

17.IBM (:IBM) :When this company talked about lofty EPS for 2015, initially the street was skeptical especially after IBM reported a blah quarter soon after the expectations were laid out. I now think the company has $20 earnings per share capabilities out three years and that $13 is doable for 2011. You keep the multiple the same and you get a $169 stock. I think it does just that. This one's cheap, way too cheap and it will be cheap next year, too, but on a bigger earnings base which is how it can get to my price target.

Now, he is obviously being conservative here, as he should be. But if IBM grows EPS to 20 w/in 3yrs, they will have an EPS growth rate of +24%!

There is no way their multiple will stay at 13. Their trailing PE will start rising again to reflect the growth, and added revenue coming out of this consequence. (Think of IBM's multiple as a "U". They had years of multiple compression, they hit bottom, now they will see expansion.)

If we really want to get theoretical, as to what PE IBM will trade at with a growth rate of 24%, history will tell us. Over the last year IBM traded with a PE/EPS growth% ratio of around 30%. (ie trailing PE of 10/15% = 0.66) This being the widest margin. If we solve for X (.66 = X/24) the minimum expected multiple will lead IBM to have a trailing PE of 16.

Which means, IBM is more of a $200 stock over the next year.

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