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IBM Stock Wins a "Double Upgrade" Ahead of Earnings: What You Need to Know

By Rich Smith – Jan 17, 2018 at 2:04PM

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Earnings arrive tomorrow. Wall Street is optimistic, and we're here to tell you why.

Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...

For the second time in as many weeks, IBM (IBM 1.82%) has won an upgrade on Wall Street. Two weeks ago to the day, we discussed RBC's prediction that IBM will grow its revenue and stabilize its profit margin in 2018. Now today, we hear that British banker Barclays Capital is also enthusiastic about IBM, awarding the computer company a "double upgrade" from underweight to overweight.

What is it exactly that has all these analysts feeling so optimistic about IBM?

Here are three things you need to know.

Cloud computing graphic illustration

Analysts expect big things from Big Blue's foray into cloud computing. Image source: Getty Images.

1. What RBC said then

Two weeks ago, RBC based its upgrade of IBM stock on a belief that IBM's mainframe revenue cycle hit its peak in the December quarter (results of which will be reported tomorrow) and will continue running strong through the end of March (creating the prospect for strong guidance on top of strong results tomorrow). The analyst also highlighted a trend seen among IBM's competitors, who have been enjoying strong sales to companies seeking to bolster their in-house IT resources with "hybrid IT" strategies -- outsourcing some computing functions to contractors like IBM.

On top of all that, RBC noted that recent weakness in the U.S. dollar relative to foreign currencies is likely to boost demand for IBM products abroad, by making them seem less expensive than foreign offerings. All of this, said RBC, will help IBM to reverse years of declining sales and improve profit margins on those sales as well.

2. What Barclays is saying now

RBC wrapped up its upgrade with a $180 price target on IBM stock -- about 7% higher than today's price. But believe it or not, Barclays is sounding even more optimistic. According to Barclays, IBM's revenue should grow far longer than sales from the mainframe revenue cycle will support. In fact, Barclays is predicting "top-line stability and maybe even modest growth" in revenue over the next "12-18 months." But perhaps more important is where Barclays sees that growth coming from.

According to Barclays, the real reason to get optimistic about IBM is that it's working to better compete with (AMZN -1.25%) and Microsoft (MSFT -2.58%) in the fast-growing and lucrative field of cloud computing. Historically, Amazon and Microsoft have been the two titans of cloud services, hosting companies' data on the web. But Barclays argues that "[t]here is room for another cloud player": IBM.

Customers may want to avoid getting locked into cloud services, argues Barclays, and would welcome the entry of a third option from IBM. And in fact, IBM has been shifting its emphasis away from its legacy hardware and software businesses and toward offering new data analytics and cloud computing services. The fact that Amazon Web Services and Microsoft's Azure have been enjoying double-digit sales growth in recent years both supports Barclays' argument that there's room for more competition here -- and offers a realistic path toward better revenue growth for IBM as it competes to take away business from the incumbents.

3. Intel's "Meltdown" is IBM's opportunity

At the same time, Barclays doesn't ignore the potential of IBM's chip business to grow, too. In fact, the analyst highlights recent troubles at Intel (INTC -2.18%) and Advanced Micro Devices (AMD -1.05%) as potentially offering IBM a helping hand.

Earlier this month, Intel and AMD were rocked by revelations that a pair of security flaws in their CPUs -- "Meltdown," which affects only Intel chips, and "Spectre," which impacts both Intel and AMD chips -- opened up computers running on these chips to new hacking risks. IBM makes a competing processor -- the Power9 -- which Barclays believes could steal market share from Intel and AMD, given that (a) their chips seem flawed, and (b) software patches designed to fix the flaws can significantly slow down their chips' performance.

Weighing how all these possibilities might improve IBM's results going forward, Barclays concludes that the stock no longer deserves an underweight rating, but should rather be overweighted in investor portfolios. It assigns IBM stock a $192 price target, implying as much as 14% upside from today's prices -- and when paired with IBM's generous 3.7% dividend yield, a total return of as much as 18%.

Will Barclays be proven right? Will RBC? We'll get our first clue tomorrow, when IBM reports its Q4 results.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Teresa Kersten is an employee of LinkedIn and is a member of The Motley Fool's board of directors. LinkedIn is owned by Microsoft. Rich Smith has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Amazon. The Motley Fool recommends Intel. The Motley Fool has a disclosure policy.

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