Reinvigorated IT Spend Could Push IBM Stock to its Best Year in a Decade

The bull thesis on legacy tech giant International Business Machines (NYSE:IBM) heading into 2020 is fairly straightforward, and it goes something like this.

Reinvigorated IT Spend Could Push IBM Stock to its Best Year in a Decade
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For years, IBM has been plagued by negative revenue growth trends as the company’s legacy businesses have lost relevancy, while its new cloud businesses have failed to gain meaningful traction. Alongside this negative revenue growth, IBM stock has dropped. But, in 2020, reinvigorated corporate spending trends across the entire information technology (IT) sector, coupled with newly acquired Red Hat related tailwinds, will push IBM’s revenue growth rate into positive territory for the first time since 2011.

This push back into positive revenue growth territory will spark a rebound in depressed IBM stock.

Importantly, we aren’t taking a “mini” rebound here. Instead, the valuation on IBM stock is so cheap — and the growth prospects in 2020 are so good — that IBM stock could actually have its best year since 2011 and rise an impressive 25% over the next twelve months.

Here’s a deeper look at how that could happen.

Tailwinds Will Strengthen in 2020

The 2020 bull thesis on International Business Machines stock is all about the company returning to positive revenue growth for the first time since 2011.

There are two big tailwinds which will help IBM accomplish this feat. First, the concurrent easing of U.S.-China trade tensions and global monetary policies over the next several months will spark a significant rebound in global corporate IT spending trends. That is, what was just 0.4% IT spending growth in 2019 thanks to escalating trade tensions and tight monetary policy, will turn into 3.7% IT spending growth in 2020 thanks to easing trade tensions and looser monetary policy, according to Gartner.

IBM makes the majority of its revenue from corporate IT spend. Thus, as corporate IT spending rebounds in a big way in 2020, that will provide a significant tailwind for IBM’s revenues.

Second, the full inclusion of newly acquired hybrid cloud player Red Hat will provide a meaningful lift to IBM’s 2020 revenues. That’s because Red Hat is a high-teens revenue growth business, while the rest of IBM has flattish revenue growth, so the inclusion of Red Hat revenue into IBM’s revenue in 2020 will help accelerate IBM’s overall revenue growth trajectory.

In sum, the convergence of an IT spending rebound with new Red Hat revenue will push IBM back into positive revenue growth territory in 2020 for the first time in nine years (the consensus analyst estimate calls for 3% revenue growth in 2020).

International Business Machines Stock Could Rally 25%

Renewed revenue growth could spark a huge rally in IBM stock in 2020, the likes of which investors haven’t seen since 2011.

The logic for big upside isn’t hard to follow. IBM will likely report somewhere around 3% revenue growth in 2020. The last time IBM reported positive revenue growth was back in 2011, and the constant-currency revenue growth rate back then was 3%. In 2011, a 3% revenue growth rate was good enough for IBM stock to fetch a 12x forward earnings multiple.

Today, IBM stock trades at 10x forward earnings. If the 2020 revenue growth rate does inch closer towards the 2011 revenue growth rate of 3%, then the underlying valuation for IBM stock should similarly inch closer towards the 2011 valuation for IBM stock. That means that over the next few quarters, IBM stock’s multiple has an opportunity to expand from 10x to 12x.

Consensus 2021 earnings per share estimate presently sit just north of $14. My modeling suggests that this is a doable 2021 profit target. Combining a historically normal 12-times forward earnings multiple with a realistic 2021 earnings per share estimate of $14, that implies a 2020 price target for IBM stock of $168.

That’s 25% higher than where IBM stock closed 2019, and would mark the best annual performance for IBM since 2011.

Bottom Line on IBM Stock

IBM stock has been a loser for several years. That’s because the company’s revenues have done nothing but drop year after year.

But, in 2020, this trend will change course. IBM will report positive revenue growth, behind accelerated IT spending trends and a big boost from Red Hat. This return to positive revenue growth could realistically drive IBM stock 25% higher over the next several months.

As of this writing, Luke Lango did not hold a position in any of the aforementioned securities. 

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