International Business Machines (NYSE:IBM) has been one of the most frustrating stocks in the market in recent years. As cloud competitors have zoomed by, IBM stock has headed south. Shares are down 46% from 2013 highs.
The novel coronavirus crisis has provided another challenge. IBM was actually showing some momentum at the beginning of the year. A fourth-quarter earnings beat in late January sent IBM stock rallying to its highest levels in almost two years. Investors welcomed new leadership, including chief executive officer Arvind Krishna.
That good news seemingly has been forgotten over the last two months. But as is the case with so many names in this market, investors are focusing too much on short-term risk, and ignoring the long-term case.
There were reasons investors were optimistic toward IBM’s long-delayed turnaround in February. Those reasons still should hold in April.
IBM Falls Behind
There’s no question that IBM was too late in pivoting toward the cloud. While Amazon (NASDAQ:AMZN) was building out Amazon Web Services in the 2000s, IBM was still focused on its legacy — and profitable — mainframe business.
Amazon Web Services now has a valuation that one analyst has estimated at half a trillion dollars. IBM’s current market capitalization is barely one-fifth that figure.
Microsoft (NASDAQ:MSFT) has executed its own impressive turnaround based on cloud efforts. Its Azure platform is a strong second place to AWS. Microsoft recently passed Apple (NASDAQ:AAPL) to become the world’s most valuable company.
IBM clearly missed out on a massive opportunity. The question is whether it’s too late to catch up.
The Pivot to Hybrid Cloud
I simply don’t believe that it is. IBM’s acquisition of Red Hat could, and should, be a game-changer.
The combination of IBM’s cloud expertise and Red Hat’s software should make the company a leader in so-called “hybrid cloud” applications.
Hybrid clouds offer more flexibility than public or private networks. They can boost security as well, allowing more critical processes to run on-premise. (Some industries aren’t legally allowed to hold data off-site.)
Hybrid clouds, when properly installed, offer the “best of both worlds.” And there may not be a better hybrid cloud developer out there than IBM, now that it has acquired Red Hat.
IBM Stock Is Cheap
To be sure, IBM stock has some catching up to do. But just as its leadership in hardware didn’t survive the rise of the public cloud, the current leaders on that front may be slow to embrace the current transition to hybrid models.
Even if IBM doesn’t take the No. 1 or No. 2 spot, the industry will be large enough for multiple winners. And IBM stock is not pricing in much winning at all.
Indeed, the stock trades at less than 10x 2019 adjusted earnings per share. IBM’s dividend yields a healthy 5.6%, and should be covered by free cash flow.
There will be a short-term hit from the current crisis. But the vast increase in employees working from home will stress corporate information technology infrastructure — and could boost IBM revenue in some areas. At the worst, IBM should easily make it to the other side of this crisis.
Take the Long View
I’ve repeatedly advised investors during this crisis to keep their focus on the long term. I don’t understate the tragedy of this pandemic. But this country, and this economy, will heal and return to growth.
I believe the same is true for IBM. Yet the short-term selloff has erased over $35 billion from the company’s market value. There’s simply no way that the short-term effects of this crisis, or even the mid-term effects of a potential recession, justify that kind of decline.
Meanwhile, investors shouldn’t forget the optimism that greeted IBM stock just a few weeks ago. Investors liked the Red Hat deal. They approved of the new CEO hire.
Indeed, as CNBC noted this week, Microsoft promoted an in-house technologist to CEO back in 2014. Under Satya Nadella, Microsoft stock has gained 360% in a little over six years.
I’m not arguing that IBM stock will see the same gains under Krishna. But there’s a real opportunity here long-term. Investors had their eye on that opportunity in February with shares above $150. They should keep that focus now, particularly with IBM stock at a much more attractive price.
Matthew McCall left Wall Street to actually help investors — by getting them into the world’s biggest, most revolutionary trends BEFORE anyone else. The power of being “first” gave Matt’s readers the chance to bank +2,438% in Stamps.com (STMP), +1,523% in Ulta Beauty (ULTA) and +1,044% in Tesla (TSLA), just to name a few. Click here to see what Matt has up his sleeve now. Matt does not directly own the aforementioned securities.