Should You Hop on the IBM 🚂?

International Business Machine (IBM) was one of the worst investments over the last two decades.

Between 2000 and 2022, the stock returned 3.17% per year.

But if you adjust for inflation, its real returns were a paltry 0.83% per year.

However, the stock recently caught fire, up almost 40% in the past year.

Revenues accelerated thanks to a focus on AI and hybrid cloud solutions.

According to our TrackStar data, financial pros believe they can.

The stock typically sees less than 20 searches during a given month, even when they report earnings.

In the last month, 97 users initiated searches, including several big money managers.

Can IBM find a way to its former glory?

Here’s what we know.

IBM’s Business

IBM is a technology titan, carving a niche innovator for over a century. 

Renowned for pioneering AI, automation, and hybrid cloud solutions, the company stands out as a beacon of progress and industrial research.

Once known for its mainframes, the company pivoted in the late ‘90s to business consulting, a decision with mixed results.

While it may have saved the company, it stagnated growth for nearly 20 years.

However, management’s push into AI and hybrid cloud computing has accelerated revenues in a way no one has seen since Clinton was President.

Below is a breakdown of the current business units:

• Software (42.5% of total revenues) – Encompasses cloud and cognitive software offerings, including Red Hat, IBM Cloud, and Watson, catering to an ever-growing demand for advanced, integrated tech solutions.
• Consulting (32.3% of total revenues) – Provides comprehensive business and technology consulting, underlining IBM’s role as a guide in the digital transformation journey.
• Infrastructure (23.6% of total revenues) – Offers critical IT infrastructure and platform services, reflecting the backbone of modern business operations.
• Financing (16% of total revenues) – Engages in client and commercial financing, alongside equipment remarketing and resale, demonstrating IBM’s financial agility.

Looking into 2024, the company expects revenue growth in the mid-single digits with $12 billion in free cash flow. 

That might not sound great. But it’s far better than the average growth over the last decade.

Financials

Source: Stock Analysis

IBM’s revenues declined during the pandemic. However, the company sold off its managed infrastructure services in 2021 to Kyndryl, which started trading on the NYSE that same year.

That immediately improved margins, especially free cash flow.

In fact, operating cash flow, which was $14.8 billion in 2019, is now $13.9 billion without the former business unit.

Capex has remained fairly low, with cash acquisitions only being the big-ticket item.

Management has kept a steady dividend payment of $6.0 billion per year, which still equates to a yield of 3.54%.

Total debt is high at $60 billion, costing $1.6 billion annually or 2.67%. So long as the company has growth opportunities, we’d be fine with spending cash elsewhere.

Valuation

Source: Seeking Alpha

Despite IBM’s recent run, shares still trade at reasonable valuations.

IBM’s P/E and price-to-cash multiples are below those of its peers. 

Wipro (WIT) comes close on both and is cheaper on an enterprise value-to-sales ratio.

But overall, IBM is the cheapest of the IT consulting firms.

Growth

Source: Seeking Alpha

Now, IBM’s growth isn’t on the same level as its competitors.

Infosys (INFY) trounced IBM’s revenue growth over the past 3-5 years as did Accenture(ACN) and Gartner (IT).

Interestingly, only IBM and Wipro had negative free cash flow growth for the past three years.

And despite a positive outlook, IBM’s growth is at the bottom of the group.

Profitability

Source: Seeking Alpha

IBM shines in its gross margins. However, it hasn’t translated those into healthy EBIT or net income margins.

However, its free cash flow margin is one of the best, contrasting the FCF growth.

This speaks to IBM’s steadier performance.

Our Opinion 7/10

This is a tough one.

On the one hand, IBM has done a remarkable job positioning itself for the future.

It’s focused on high-profit categories with exceptional growth.

Yet, legacy costs hang over its head. And we’re not sure it’s become as dynamic as needed.

We won’t knock anyone looking to add IBM to their portfolio here, especially with the healthy dividend and outlook.

However, $140-$160 would be a better entry point with a firmer cushion of safety.

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