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Why IBM Is Replacing Cisco in an Equity Income Model Portfolio

There is a new call you haven’t heard for quite some time, at least not very often: Buy IBM! Before you just rush out and do so, consider what the real meaning of the call is. Argus has added International Business Machines Corp. (NYSE: IBM) to its equity income model portfolio. The addition appears to come at the expense of Cisco Systems Inc. (NASDAQ: CSCO).

Calls of this nature are often difficult to follow without a formal upgrade or downgrade, and they very rarely get covered by the media. It should also not be considered a formal analyst upgrade. Yet, Argus did formally upgrade of IBM back on August 26 with a $175 price target.

What looks to have occurred here is that Argus made a change in its technology picks in the equity income model portfolio. Note that the last rating we saw at Argus on Cisco was a Buy rating and a whopping $36.00 price target, but that was on August 13.

On the removal of Cisco from the model portfolio, the firm addressed its earnings trends announced of late with 4% annual sales growth and 6% sequential growth, with 7% earnings per share growth. The reason for the elimination was as follows:

Cisco recently welcomed new CEO Chuck Robbins, succeeding John Chambers after his 20-year run. The new CEO has already put in place his team and removed several legacy executives associated with Chambers. After initial enthusiasm for the executive change, CSCO investors may shift into neutral while they analyze the impact of changes at the top. Since inclusion in September 2012, the CSCO shares have advanced 33% while underperforming the benchmark by 1,300 basis points.

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So, why add IBM to its model portfolio here? Argus said:

Using asset sale proceeds and cash on hand, we are establishing a position in the IBM shares of International Business Machines. … We recently upgraded the IBM shares based on valuation and prospects for easier comparisons and better operating performance in the coming quarters. IBM’s earnings are likely to decline in 2015, and revenue will continue to decline this year and into 2016. IBM’s earnings quality should steadily improve, however, as the company benefits from the disposition of commodity-like assets and the development of next generation strategic imperatives in the areas of cloud, big data, SaaS, enterprise mobility, and security.

What Argus sees is that IBM has prioritized its strategic businesses with solid double-digit growth. They like that IBM is partnering to accelerate development and continuing to provide essential high-value enterprise IT. On two-year forward forecast earnings per share, IBM shares trade at discounts to their five-year historical multiples and also at steep discounts to their historical relative multiples. The model portfolio change included the following:

We believe that this multiyear relative underperformance of the stock, capped by non-fundamental weakness during the late-August market meltdown, has resulted in an attractive valuation. The IBM shares currently provide an annual dividend yield of 3.6%.

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IBM shares closed most recently at $144.97 but were listed as a $143.00 price in the Argus model portfolio change. IBM’s consensus analyst price target is $158.33, and it has a 52-week trading range of $140.62 to $190.89.

Cisco Systems was trading at $25.99 on Thursday, and it has a consensus price target of $31.02 and a 52-week range of $22.49 to $30.31.

By Jon C. Ogg


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