International Business Machine’s Outperformance Is Poised to Continue

In my column on International Business Machine’s (NYSE:IBM) that was published on Dec. 13, my headline proclaimed that “IBM Stock Will Be a Good Fit for the 2022 Macro Environment.” So far, my prediction has been correct, as IBM stock has far outperformed the Nasdaq in recent months.

Photo of IBM (IBM) building as seen through the canopy of a tree. IBM logo is in large letters on side of building.
Source: shutterstock.com/LCV

Specifically, since Dec. 13, IBM’s shares have climbed 6.18% and changed a little since the beginning of the year.  Also important to note is that the shares have a 5% dividend yield, meaning their owners will profit even if they stay little changed in 2022.

But I do expect the shares to advance significantly this year, given the “new IBM’s” solid growth, strong profitability, and longer-term potential. And I predict that the shares will ultimately outperform the Nasdaq in 2022, even excluding IBM’s ample dividend.

Analyzing IBM’s Q4 Results

Impressively, in the fourth quarter, IBM’s software revenue jumped 10% year-over-year, and its consulting sales soared 16% YOY. The software unit’s increase factors in about five percentage points of YOY growth from the new IBM’s relationship with Kyndryl (NYSE:KD), which owns old IBM’s spun off assets. Still, any revenue that IBM receives from Kyndryl, in my opinion, does make its stock more valuable.

The units’ sales increases were impressive, considering that IBM has a reputation as a “low-growth” or “no-growth” company. Also importantly, the combined revenue of software and consulting account for more than 70% of new IBM’s revenue.

IBM CEO Arvind Krishna indicated on Jan. 24 that the company’s consulting business was benefiting from the difficulties that tech firms are having finding employees. Also helping IBM’s consulting  unit are strong demand for the integration of artificial intelligence (AI) systems and the increased use of cybersecurity tools, the CEO explained.

Meanwhile, the company’s hybrid cloud business is performing strongly, in-line with the prediction that I made in my previous article on IBM stock. Specifically, at the end of Q4, Big Blue had “more than 3,800 hybrid cloud platform clients,” up from around 1,000 at the beginning of 2021.

The growth of the company’s hybrid cloud business, along with the strength of its consulting unit, is helping to boost its software sales and its consulting revenue.

The company’s Q4 operating earnings per share came in at $3.35, and its operating pretax income was $3.5 billion, so Big Blue remains solidly profitable.

2022 Guidance and Areas Likely to Improve

After generating $6.5 billion of free cash flow in 2021, IBM expects that number to jump to $10 billion-$10.5 billion this year. Although some of the increase reflects lower taxes and reduced charges from the Kyndryl spin off, it’s still an impressive gain, fueled partly by IBM’s growth acceleration and margin increases.

On the top line, the company anticipates an increase of around 5%, excluding currency fluctuations.

In 2022, IBM expects its pre-tax software margin to come in at only about 25%. That’s a very low margin for a software business. I believe that, as the unit’s execution improves due to ongoing changes made by Krishna in the medium-to-long-term, the business’s reputation will be greatly enhanced. That will enable the unit to charge significantly higher prices and lift its margins.

I expect a similar phenomenon to, over time, raise the margins of the consulting unit, whose 2022  pre-tax margin is  only expected to be around 10%-12%.

Additionally, as the units’ strong revenue growth continues, economies of scale should also help lift their margins.

Finally, IBM’s sales from “Data and AI” increased just 3% YOY last quarter, while its “security revenue declined modestly,” Krishna reported.

In general, the demand for AI and cybersecurity are growing rapidly among tech companies. Therefore, I believe that — as a consequence of acquisitions, improved execution by IBM, and the enhanced reputation that should be formed as a result of its execution upgrades — the revenue growth of the company’s AI and security businesses should greatly accelerate in the medium-to-long term.

The Bottom Line

IBM’s growth is accelerating, while it remains quite profitable. Meanwhile, both of those trends  are likely to intensify going forward, and the valuation of the shares, which are trading at a price-earnings ratio of just 19.84, is still attractive.

Given these points, I expect the stock to continue to outperform over the longer term, and I think that it remains a very good choice for conservative investors looking for exposure to a tech name.

On the date of publication, Larry Ramer did not hold a position in any security mentioned in the article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

Larry Ramer has conducted research and written articles on U.S. stocks for 14 years. He has been employed by The Fly and Israel’s largest business newspaper, Globes. Larry began writing columns for InvestorPlace in 2015.  Among his highly successful, contrarian picks have been GE, solar stocks, and Snap. You can reach him on StockTwits at @larryramer.  


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