During the first quarter of 2016, International Business Machines Corp. (NYSE:IBM) stock reached lows that had not been seen since 2010. Of course, there was lots of buzz that Big Blue was washed up. Better to invest in the hot plays like Facebook Inc (NASDAQ:FB) and Alphabet Inc (NASDAQ:GOOG, NASDAQ:GOOGL), right?
Well, of course, IBM stock proved that it still had some life left. For the year so far, the return is at about 21%. By comparison, FB has gained 12% and GOOG is up only about 3%.
Although, about half of the gain for IBM stock came after the election of Donald Trump. So perhaps the company will benefit from the expected spike in infrastructure spending — which will require sophisticated IT investments? And maybe there will be a nice benefit from corporate tax reform?
Perhaps so. But there are certainly other advantages to consider — as well as risks. So let’s take a look:
IBM Stock Pros
Global Juggernaut: With a history that goes back over 100 years, IBM is definitely a highly trusted brand, especially with mission-critical functions.
The IBM platform is also quite broad and has a presence in over 175 countries. For example, there is IBM Global Business Services (GBS). This is the consulting organization, which helps customers with implementations of new systems and maintenance of existing ones. IBM has been getting lots of traction from mobile as well as cloud deployments for Salesforce.com, Inc. (NYSE:CRM) and Workday Inc (NYSE:WDAY).
What’s more, the company has assembled an impressive portfolio of hardware and software assets. Just some include Watson, Tivoli (asset management), WebShere (for business applications) as well as a variety of high-powered mainframe computer systems.
Watson: This is essentially an AI (Artificial Intelligence) system that can learn by processing huge amounts of information.
While still in the early stages, Watson has tremendous potential – and wide applications. After all, take a look at Watson Health, which is helping with life sciences, imaging, valued-based care and oncology. Actually, Finland and Italy are using the technology to assist doctors in providing better treatments.
What’s more, Watson has been making wave in other important categories, such as virtual assistants for customer service, the Internet-of-Things (IoT), financial services, weather forecasting, regulatory compliance and even cybersecurity.
Then again, IBM has led the list for 23 consecutive years for patents issued. And yes, a big part of this has led to the advancements in Watson.
Financials and Valuation: IBM continues to crank out strong cash flows, which came to $4.2 billion in the latest quarter. The company has also been shareholder friendly, with the dividend yield at an attractive 3.4%. Consider that the company has increased the payout for 21 straight years and has not missed a payment since 1916!
The valuation on IBM stock is also reasonable. Keep in mind that the forward price-to-earnings ratio is at about 12X. By comparison, both Microsoft Corporation (NASDAQ:MSFT) and SAP SE (ADR) (NYSE:SAP) are at about 19X.
IBM Stock Cons
Growth Issues and Complexity: IBM has reported revenue declines for a grueling 18 consecutive quarters. This has come despite making strides in growth segments like cloud computing, analytics and AI. Then again, these strategic imperatives still account for only about 40% of revenues.
Let’s face it, managing IBM is no easy feat because of the many different categories (hey, just try reading through the 10-Q!) Going forward, the company may want to focus on just a few of the businesses, like Watson and the cloud segment, and spin-off or sell the rest. This is a strategy that has worked quite well for Hewlett Packard Enterprise Co (NYSE:HPE), whose shares are up 54% for the year so far.
Image Creation: Is there really a turnaround at IBM? Or is the company just being too loose in how it defines its business? For example, by making some tweaks to old-line software, IBM could perhaps include the revenues in its strategic imperatives segment.
Then there are the ongoing work reductions and stock buybacks.
Well, such moves may not last long. According Credit Suisse Group AG (ADR) (NYSE:CS) analyst Kulbinder Garcha: “However, our closer examination highlights that a series of nonoperational, nonrecurring items are supporting the EPS. We believe the structural profitability may continue to erode.”
For 2017, his EPS forecast for IBM stock is $12.64. The Street, on the other hand, is looking at a consensus of $13.90.
Legacy Businesses: The fact is that a large part of IBM’s software and systems are based on older technologies, such as on-premise approaches. Granted, this does not necessarily mean that there is a threat of disruption. Keep in mind that companies are highly resistant to make changes to core technologies. However, it is important to note that there will still likely be sluggish growth. After all, as seen in the latest quarter, the software segment revenues increased by only 3% to $5.7 billion.
Another issue is that it is tough for a company like IBM to transition to newer technologies, such as cloud computing. It’s expensive and time consuming. More importantly, there is the risk of disrupting existing customer relationships.
Now other tech operators like Adobe Systems Incorporated (NASDAQ:ADBE) have shown that the changes can be successful. But as for IBM, it is a company that is at a much larger scale – and it has been fairly late in its moves as well.
Verdict on IBM Stock
Pulling off a turnaround of a massive organization like IBM is no easy feat. But CEO Virginia Rometty has done a pretty good job so far. If anything, the company looks positioned to benefit from one of the megatrends in technology: AI. This kind of technology is likely to be a gamechanger. IBM also has the ability to get wide-scale adoption because of its trusted brand, global infrastructure and large customer base.
Besides, the yield on the stock is attractive and the company should continue to crank out strong cash flows.
So is now a good time to buy IBM stock? I think so — the company seems to be at an inflection point, where growth could be on the verge of returning once again.
Tom Taulli runs the InvestorPlace blog IPO Playbook and is a registered investment adviser representative (you can visit his site to learn more about his financial planning services). He is also the author of various books on investing like All About Commodities, All About Short Selling and High-Profit IPO Strategies. Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.
