It feels weird to say it, but shares of legacy tech giant International Business Machines (NYSE:IBM) is off to an explosive start in 2020. Year-to-date, IBM stock — traditionally a sleeper on Wall Street given the company’s lack of profit growth — is up 13%, versus a less than 4% gain for the S&P 500.
Why the sudden surge in IBM stock? Because there has been a sudden surge in IBM’s growth trajectory.
That is, the company acquired hyper-growth hybrid cloud player Red Hat in 2019, and the integration of Red Hat’s numbers pushed IBM’s growth rates in the fourth quarter of 2019 to levels not seen in years. Revenue growth rose 3% in constant currency, powered by 23% growth in the cloud business and 24% growth from Red hat. Gross margins expanded more than 200 basis points. Profits were largely stable year-over-year.
In response to this sudden surge in the company’s growth trajectory, IBM stock has popped to start 2020.
That’s the good news. The better news? IBM’s growth trajectory will continue to improve throughout 2020. Revenues will rise. Margins will rise. Profits will rise.
And, as all those important operational metrics rise, so will IBM stock.
Growth Trajectory will Keep Improving
In 2020, two big catalysts will keep IBM’s growth trajectory on a solid upward path.
First, resurgent global information technology (IT) sector spending on the back of easing monetary conditions and trade tensions will provide macro-tailwinds for IBM’s various tech businesses. That is, in 2018, global IT spending trends were weighed by tightening monetary policy.
In 2019, they were weighed by escalating U.S.-China trade tensions. In 2020, however, monetary policy is exceptionally accommodating across the globe, while trade tensions are meaningfully de-escalating.
Against that backdrop, corporations globally will re-up their IT spending plans this year. That’s why, according to Gartner, IT spending growth will accelerate from 0.4% in 2019 to 3.7% in 2020. This acceleration will create significant tailwinds for IBM’s various tech businesses, which are built on the back of IT capital spending.
Second, the inclusion of Red Hat into IBM’s operating business will create financial tailwinds everywhere. Of course, as a 20%-plus revenue grower with a big gross margin profile, Red Hat will naturally push IBM’s overall revenue and profit growth rates higher in 2020. But, more than that, Red Hat will create multiple cross-selling opportunities in IBM’s core cloud business and those new cross-selling opportunities should provide a spark for IBM’s sluggish cloud business.
Net-net, reinvigorated IT spending coupled with boosted cloud growth from Red Hat will keep IBM’s growth trajectory on a solid upward path in 2020.
Shares Remain Relatively Cheap
Considering that the company’s growth trajectory will meaningfully improve over the next few quarters, IBM stock remains cheap at current levels.
The stock trades at 11.3-times forward earnings. That’s dirt cheap. Sure, some of that cheapness is a byproduct of the fact that IBM’s revenues and profits have gone nowhere in years.
But, revenues and profits are going to start charging higher again in 2020. The last time IBM was posting consistently positive revenue and profit growth? Back at the start of 2010s. At that time, the stock was fetching a 12-times forward earnings multiple.
It seems reasonable to assume that, as IBM returns to positive growth, the stock returns to trading at 12-times forward earnings.
Assuming so, let’s do some math. Consensus sell-side estimates for 2021 earnings sit around $14 per share. Throw a 12-times forward multiple on that. You arrive at a 2020 price target for the stock of $168.
That’s way above where shares trade hands today.
Bottom Line on IBM Stock
IBM is off to an unusually explosive start in the new year because the company’s growth trajectory is turning positive for the first time in a decade.
The growth trajectory will keep improving over the next few quarters. As it does, IBM stock will keep pushing higher.
As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.
