International Business Machines Corp. (NYSE:IBM) is in all the growing markets, but IBM stock still languishes. Though the stock is up around 12% from yearly lows, other mega-cap technology stocks are outperforming it.
Microsoft Corporation (NASDAQ:MSFT) is up almost 40% from lows, as investors enjoy the company’s growth in cloud software. Apple Inc. (NASDAQ:AAPL), which just refreshed its line of iPhones, is at yearly highs and may move higher. But IBM is taking its clients through emerging trends in technology. This includes quantum computing, blockchain, and artificial intelligence.
IBM Does Data
IBM knows how to build solutions around processing massive amounts of data. It has the know-how in building the architecture that would support AI.
When it comes to databases, Oracle Corporation (NYSE:ORCL) and Microsoft lead the markets, but IBM helps its clients build NoSQL databases (non-relational), big data and Hadoop. In short, demand from customers for these technologies is giving IBM’s revenue much-needed support.
IBM’s near-term headwind is growing sales at a rate fast enough to pay off its debt. Its long-term debt/equity ratio is around two times, compared to 0.85 times for Microsoft and 0.73 times for Apple. IBM’s biggest businesses are growing the slowest. The faster-growing units, like the ones that integrate and run applications on the cloud, are still small revenue contributors for IBM.
AI Is Not Just a Buzzword
IBM recognizes the market size for AI. Enterprises need two AI streams: one for the consumer and the other for the enterprise. Even though the two areas differ by the volume of data, building the machine-learning tool to harness that data is the same.
IBM would probably gladly analyze consumer data sets since they are so large. As it develops the applications, be it for the Internet of Things or financial or healthcare markets, the company has plenty of potential for growing its sales in the AI market.
Three Different Clouds
Since customers may demand private, public or hybrid clouds, IBM sells solutions for all of them. Do not be surprised if it crosses paths with giant networking firms like Juniper Networks, Inc. (NYSE:JNPR) or Cisco Systems, Inc. (NASDAQ:CSCO).
Still, in the third quarter, IBM’s sales came from other divisions. Cognitive Solutions accounted for $4.4 billion of sales, while Global Business Services added $4.1 billion in revenue. But as cloud demand continues, it will become pivotal to IBM’s turnaround in stabilizing revenue growth. Last quarter, cloud revenues grew 20% to $4.1 billion.
IBM is a relatively inexpensive stock at a 13x P/E and a forward P/E of 11x. IBM stock pays a dividend yielding around 3.9%. MSFT stock only pays a dividend of 2%, and Apple pays its shareholders even less at 1.5%.
Though IBM stock is cheap because its growth prospects are poor compared to the others, it could reward investors in the longer term. A 10-year DCF EBITDA Exit model would give IBM stock a $200 price target. The valuation assumes revenue will stop declining by fiscal 2018 and that revenue will stay flat or grow modestly (by up to 1.5%) through to fiscal 2026.
Click to Enlarge Investors may comfortably assign a low discount rate of between 9.5% and 10.5%:
Takeaway on IBM Stock
IBM stock is creeping higher, undoing its drop that began in mid-November. Given the slow growth dynamics and even flat-to-declining revenues, the company would suit income and value investors. Growth investors should look elsewhere and maybe buy Cisco, Microsoft, or Apple stock instead.
Disclosure: Author does not own shares in any of the companies mentioned.