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Better Buy: Apple Inc. vs. IBM

By Jeremy Bowman – Jul 28, 2016 at 9:06AM

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Which of these two tech giants is the better play?

To the consumer, Apple (AAPL -1.96%) and IBM (IBM -0.26%) may not seem to have much in common. While both are tech companies, Apple's brand has become prevalent across technology in smartphones, computers, tablets, and other gadgets. IBM, on the other hand, operates behind the scenes, in software and services.

However, to investors, Apple and IBM bear much in common. Though many tech stocks attract sky-high valuations, Apple and IBM both trade near a P/E of 10, as investors seem skeptical of their future growth. Increasingly, the two have become classic value plays for investors, attractive because of their steady cash flows, dividends, and share buybacks rather than their innovation or future growth. Both have seen revenues decline recently, as well.

For investors looking to get behind one of these tech stalwarts, it's worth asking which is the better choice. Let's take a closer look to see what each company has to offer.

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The iPhone maker hits a speed bump

Apple has been one of the best stock picks of the 20th century, going from a struggling computer maker in the 1990s to the world's pre-eminent gadget maker, but the iPhone maker's growth seems to have finally caught up with it. After 13-straight years of revenue increases, Apple saw sales slide in its second quarter, and that pattern continued in its third-quarter report out this week.

The iPhone, the source of more than two-thirds of Apple's revenue, has seen sales decline over the past two quarters due to weakening Chinese demand, and longer upgrade cycles, as many carriers have eliminated subsidies. The decline also signals that consumers were unimpressed with the iPhone 6S, though the franchise is about to get a major upgrade in September when the iPhone 7 is released. 

Revenue in the recent quarter fell by 15%, and profits were down 27%, though both figures beat analyst estimates. Apple appears to be at a crossroads, as demand for its core products -- iPhone, iPad, and Mac -- have stalled, and adoption for new releases, like the Apple Watch, has been slow.

The company is increasingly looking toward services to shore up its cash flow, counting on features like the App Store, Apple Music, and Apple Pay to provide steady income in the face of volatile device sales. Services revenue grew 19% in the last quarter, to nearly $6 billion, but that was a rare bright spot in Apple's report. The company is projecting another revenue decline for the current quarter, but the low bar set by analysts may give Apple stock some life.

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Not so Big Blue

While Apple has seen revenue decline for two quarters in a row, IBM's sales have long since plateaued, falling for more than four years in a row as part of a strategic shift to software and services, as the company sheds legacy hardware divisions. In its most-recent quarter, IBM's revenue fell 2.8%, to $20.2 billion, but sales in its strategic imperatives, which includes cloud, analytics, and security, among others, grew 12%, to $8.3 billion.

IBM shares reached a 52-week high following the earnings report, as the results beat estimates. Investors may believe that the company's transformation is on track, even as adjusted earnings per share fell 23%.

IBM has slowed its once-aggressive share-buyback program after abandoning its target of $20 in earnings per share by 2015. Instead, the company sees adjusted EPS falling by 9% this year, to $13.50. While the tech mainstay is making progress on its strategic priorities, it's unclear when investors should expect a return to revenue or profit growth. Moreover, gross margin has declined over the last three quarters, calling into question IBM's claim to be transitioning to higher-margin businesses.

Which is the better buy?

While both companies have struggled recently, IBM's revenue decline has persisted far longer than anyone expected, and the company's big miss on its $20 EPS goal underscores the fact that management's strategy is not paying off as it had projected.

With Apple, there's reason to believe that the company's setback is temporary, as iPhone sales are down this year in large part due to the success of the iPhone 6, released in the previous fiscal year, which likely led to early upgrades and tough comparisons for the 6S. If the iPhone 7 can deliver a meaningful upgrade, Apple should return to growth next fiscal year. Additionally, the steady growth in recurring revenue from services is encouraging, as Apple's installed base has passed 1 billion devices.  

Though IBM's new strategy may eventually bear fruit, Apple is the more likely of the two to return to growth in the near future. This makes it the better buy of these two tech giants.

Jeremy Bowman owns shares of Apple. The Motley Fool owns shares of and recommends Apple. The Motley Fool has the following options: long January 2018 $90 calls on Apple and short January 2018 $95 calls on Apple. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Apple Stock Quote
Apple
AAPL
$148.11 (-1.96%) $-2.96
IBM Stock Quote
IBM
IBM
$148.37 (-0.26%) $0.38

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