Good old IBM (IBM -0.68%) roared into 2018 on a full tank of rosy management comments, some fresh analyst upgrades, and solid market momentum. Two less-impressive earnings reports later, Big Blue's shares are trading 14% below January's 52-week highs.
IBM's stock now costs just 11 times free cash flow. Would this be a good time to pick up a few shares of the technology giant? Let's find some clues in IBM's most recent earnings update.
A lesson in recent history
The second-quarter report edged out Wall Street's expectations across the board and share prices jumped as much as 4.2% the next day. A five-year streak of negative year-over-year revenue growth was broken in January, and IBM has now developed a refreshing habit of positive growth.
Investors and analysts are catching a glimpse of light at the end of that long, dark tunnel.
IBM's long run of shrinking sales comes from an ambition to keep the company relevant for another few decades. The old model, which offered a one-stop shop for everything an enterprise data center might have needed in the era of on-premise servers and storage, was so successful that rivals from Oracle to Hewlett-Packard Enterprise started to copy IBM's playbook.
And that was the exact moment when then-CEO Sam Palmisano stepped down to make way for new thinking and fresh blood. Under current CEO Ginni Rometty, IBM has spun off or sold most of its low-margin hardware businesses to refocus on a new collection of high-growth operations -- with an eye to the long-term future.
Known as IBM's strategic imperatives, this banner covers ideas such as artificial intelligence, cloud computing, data security, and deep data analysis.
Image source: Getty Images.
There's a big bounce coming
Once again, HP and Oracle are following IBM's lead. The market is changing and everybody needs to change along with it. IBM saw this before the competition and took strong action right away. That was absolutely the right decision from a long-term perspective, even if it led to a few years of tightening sales and stock market pain.
The company is turning a corner right now, as shown in two crucial business metrics:
- Sales are growing again, suggesting that IBM hit the bottom of the cycle in 2017 and is ready to turn back up again.
- Strategic imperatives accounted for more than half of IBM's total revenue in the second quarter. That's a first.
The two bullet points are obviously tightly linked, as strategic imperatives are driving IBM's revenue growth as well as its trend toward widening margins. In the second quarter, strategic imperatives sales rose 15% year over year while IBM as a whole scored a more modest 4% revenue boost.
Yet IBM's stock is back to where it was 52 weeks ago while the S&P 500 notched a 14% gain over the same period. You've already seen the skimpy price-to-free-cash-flow ratio.
This household name is about to go places, but many investors will be left behind. In my eyes, IBM is a no-brainer of a buy right now. Mr. Market will eventually come to his senses and give IBM the premium-grade valuation it deserves. He'll just need some time to get over the disappointments of the last five years first.
