IBM is one of August’s Most Attractive Stocks. And like all of our Most Attractive Stocks the company has (1) high and rising economic profits (as distinct from accounting profits**) and (2) a cheap valuation. As shown in our report on IBM, the company’s ROIC is in the 2nd Quintile of all the companies we cover. At the same time, the stock boasts a 10% FCF Yield and our dynamic discounted cash flow analysis shows the current stock valuation implies that the market believes IBM’s profits will decline by 10% and never grow after that decline. In other words, the stock is priced for permanent profit contraction – no growth ever.

HIDDEN GEM: Our detailed valuation model shows that IBM grew its “economic” profits more than it accounting profits during its last fiscal year. Economic profits rose by $1.15bn while accounting profits rose by $1.09bn. For details on what causes the difference between Economic Versus Accounting Profits, see Appendix 3 on page 10 of our free report on IBM.

See Appen­dix 4 to learn how IBM increased NOPAT by cut­ting costs and increased its NOPAT Mar­gin. See Appen­dix 5 for details on how IBM cut its Invested Cap­i­tal to offset the drop in revenue and keep its Invested Cap­i­tal Turns close to 1.0. Appen­dix 7 (in the Return on Invested Cap­i­tal sec­tion) shows how the improved NOPAT Mar­gin and steady Invested Cap­i­tal Turns result in an increase in ROIC (to 14.1% from 12.1%) and Eco­nomic Profit, which rose by $1.15bn while Net Income rose by only $1.09bn.

As per Investment Strategy 101 and How to make money picking stocks, IBM fits the profile of a great stock to buy.

**See Finance 101 and Economic Versus Accounting Profits for more detail on why accounting profits are not reliable indicators of corporate profitability or value creation.

Note: Stock pick of the week is updated every Tuesday.