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International Business Machines Corp. Stock Still Looks Overvalued

Even at $150, IBM stock is overvalued

By Luke Lango, InvestorPlace Contributor

IBM Stock: One of the Most Attractive Yields in Tech

Source: Shutterstock

In early January 2018, blue chip tech giant International Business Machines Corp. (NYSE:IBM) was in rally mode. At the end of December, IBM was a $150 stock. Three weeks into January, IBM stock was at nearly $170.

I warned that the early 2018 rally in IBM stock was overdone. The valuation on the stock was simply too big to be supported by mundane growth prospects. Consequently, I said fade the rally.

Fast forward a few months, and IBM stock price today is back to $150.

While some bulls may view recent weakness as a buying opportunity, I’m not so sure. Even at $150, IBM still looks overvalued to me. The valuation is bigger than normal, but the underlying growth narrative doesn’t really support a bigger-than-normal valuation.

All together, I don’t see IBM heading much higher than $170 over the next 4 years. That would imply meager 3% returns per year from today’s $150 level.

That isn’t enough return for me to get excited. That is why I’m still avoiding IBM stock.

Here’s a deeper look.

IBM Offers Muted Growth Prospects

IBM feels like yesterday’s favorite tech company, and despite the company’s best efforts to modernize the business, it is still yesterday’s favorite tech company.

Bulls are excited about what IBM calls its Strategic Imperatives businesses. Those businesses include cloud (revenues +27% last quarter), security (+127%), mobile (+21%), and analytics (+6%). Overall, the Strategic Imperatives side of IBM is growing around 14% year-over-year.

But this growth will inevitably slow over the next several quarters and years.

Competitors are running past IBM’s cloud business. IBM’s cloud business is essentially the slowest growing cloud business among notable players. Indeed, of the 5 largest cloud players in the market, IBM is the only one losing market share.

Peers Amazon.com, Inc. (NASDAQ:AMZN), Microsoft Corporation (NASDAQ:MSFT), Alphabet Inc (NASDAQ:GOOG), and Alibaba Holdings Ltd (NYSE:BABA) are all gaining market share.

Clearly, IBM Cloud is being left in the dust. That is a big deal because cloud is a big part of IBM’s hyper-growth Strategic Imperatives business (roughly 50% of revenues). Consequently, Strategic Imperatives revenue growth will slow meaningfully with IBM Cloud.

That is bad news. Strategic Imperatives is the only thing really growing at IBM, and all together, Strategic Imperatives revenue accounts for 46% of total revenues. As for the other 54% of IBM’s business? It is in secular decline.

If you put everything together, then, you can see that this is a really low-growth company. The growth side of the business will be subject to slowing growth, while the non-growth side of the business will keep falling. That means today’s 1% revenue growth rate will inevitably slow over the next several years.

At best, this is a 0-1% revenue growth story over the next 5 years with some good margin drivers (as the cloud business scales, margins should head meaningfully higher). Revenues last year were $79.1 billion, while pre-tax profit margins were 14.4%.

At best, revenues grow by 1% per year over the next 5 years while pre-tax profit margins jump to 20% (roughly in-line with historical standards). That would put revenues at $83.1 billion and pre-tax profits at $16.6 billion in 5 years. Taking out 16% for taxes and dividing by presumably 850 million diluted shares, you get to earnings per share of roughly $16.40.

IBM historically trades around 10.4-times forward earnings, with not much variance in that multiple. Applying that reasonable multiple to $16.40 in earnings that are 5 years out gets you to a 4-year forward price target of roughly $170.

Bottom Line on IBM Stock

IBM isn’t overheated anymore. But it is definitely still overvalued.

It is tough to justify paying an above-normal valuation for a company that has such small forward looking growth prospects. I really don’t see this stock heading much higher than $170 over the next several years, and because of that, I’m not terribly interested in IBM stock at $150.

As of this writing, Luke Lango was long AMZN, GOOG, and BABA.

Article printed from InvestorPlace Media, https://investorplace.com/2018/03/ibm-stock-still-overvalued/.

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