Legacy technology giant International Business Machines (NYSE:IBM) reported second-quarter earnings in late July which excited Wall Street and charged up IBM stock for one very simple reason: The numbers show early signs that the long-overdue cloud-powered turnaround at IBM is finally emerging.
Specifically, IBM reported 34% adjusted revenue growth in its cloud business in the quarter, up from 23% growth last quarter and 14% growth last year.
Indeed, it marks the best revenue growth rate IBM’s cloud business has reported in years.
And management commentary on the call implied that this reinvigorated momentum in the cloud business is here to stay.
So is time to buy IBM stock as the company enters a new era of cloud-centric growth?
I think so. Here’s why.
The Cloud Turnaround Is Here
For years, IBM has been a legacy technology company that has failed to keep up with the times, and consequently, suffered from a persistently negative growth trajectory.
This negative growth trajectory looks due for a sharp reversal over the next few years.
Specifically, in 2019, IBM closed its acquisition of Red Hat, a move which created a solid foundation upon which IBM could reinvigorate its growth trajectory with an up-and-coming hybrid cloud business.
There were some hiccups early on in integrating Red Hat into the IBM empire. Second half 2019 numbers weren’t great.
But second-quarter 2020 numbers were great.
Those integration hiccups are now in the rear-view mirror. Covid-19 has accelerated the shift of enterprises to hybrid cloud work environments. And IBM’s hybrid cloud business is starting to take off, with a multi-year-high 34% adjusted revenue growth rate in Q2.
Given that only 20% of enterprise workloads have migrated to the cloud — and that most companies opt for a hybrid cloud model, because workloads aren’t a one-size-fits-all thing — IBM has a clear opportunity to sustain robust momentum in it hybrid cloud business over the next few years.
That’s especially true since Covid-19 has accelerated the future of work, which involves a hybrid remote and in-office environment (for which hybrid cloud solutions are ideal).
Big picture: early signs of a cloud-powered turnaround at IBM are emerging. If this turnaround persists over the next few years, IBM stock will power higher.
IBM Stock Is Cheap
Central to the bull thesis on IBM stock is that, because the company has reported negative revenue growth for years, Wall Street isn’t buying into the cloud.
So, IBM stock is dirt cheap.
We’re talking 11-times forward earnings. And 7-times trailing cash flow. With a 5% dividend yield.
For perspective, IBM’s peers — systems software stocks — are trading at 30-times forward earnings right now. Meanwhile, the S&P 500 has a dividend yield of 1.8%.
Thus, if IBM does successfully pull off a cloud-powered turnaround over the next few years — which, given Q2’s strong cloud numbers, looks increasingly likely — then IBM stock could fly as improving growth trends converge on a discounted valuation, forward estimates move higher and the underlying multiple expands.
How much upside potential does IBM stock have?
According to my numbers, renewed hybrid cloud growth could drive steady ~2% overall revenue growth per year over the next five years. On top of that, a pivot towards a more scalable, higher-margin software business model should boost gross margins. Buybacks will factor in, too, over time.
Connecting those dots, I think IBM can power earnings per share to $15 by 2025.
When IBM was growing back in 2011, the stock fetched a 12-times forward earnings multiple.
Based on a 12-times forward multiple, that implies a 2024 price target on IBM stock of $180. Discounted back by 5% per year — taking my usual 10% discount rate and subtracting out the 5% yield — you arrive at a 2020 price target for IBM stock of nearly $150.
Thus, over the next ~6 months, I see IBM stock rising ~25%.
Bottom Line
IBM stock isn’t a great growth stock to buy and hold for the long run.
But, in a market that’s somewhat extended and full of richly valued tech stocks, IBM stock is a solid value tech stock to buy for safety and growth.
Luke Lango is a Markets Analyst for InvestorPlace. He has been professionally analyzing stocks for several years, previously working at various hedge funds and currently running his own investment fund in San Diego. A Caltech graduate, Luke has consistently been rated one of the world’s top stock pickers by various other analysts and platforms, and has developed a reputation for leveraging his technology background to identify growth stocks that deliver outstanding returns. Luke is also the founder of Fantastic, a social discovery company backed by an LA-based internet venture firm. As of this writing, he did not hold a position in any of the aforementioned securities.
