Over the past decade, IBM (IBM +2.72%) and Oracle (ORCL +3.11%) both struggled to grow their cloud segments to offset the slower growth of their legacy businesses.
IBM dialed back its buybacks and bought companies like Softlayer and Red Hat to bolster its "strategic initiatives" in the cloud, mobile, analytics, social, and security markets. Oracle bought some big companies like NetSuite, but also accelerated its buybacks to boost its earnings without generating any meaningful revenue growth.
IBM and Oracle's stocks both advanced nearly 20% this year, but still underperformed the S&P 500's near-30% gain. Will either "mature" tech stock fare better next year? Let's examine their core businesses to find out.
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IBM's strengths and weaknesses
IBM splits its business into five main units: cloud and cognitive software (29% of its revenue last quarter), global business services (23%), global technology services (37%), hardware systems (8%), and global financing (2%).
Only two units -- cloud and cognitive software and global business services -- generated year-over-year revenue growth last quarter. The other segments struggled with macro headwinds, cyclically lower demand for its mainframes, and a downsizing of its financing unit.
IBM is counting on three main tailwinds to drive its long-term growth: more hybrid cloud deployments (which bridge private clouds with public cloud services), a fresh upgrade cycle for mainframes, and its acquisition of Red Hat, which could contribute two points to IBM's compound annual revenue growth over the next five years. Analysts expect IBM's revenue to dip 3% this year, but rebound 3% next year as these catalysts kick in.
Oracle's strengths and weaknesses
Oracle splits its business into four main units: cloud services and license support (71% of its revenue last quarter), cloud license and on-premise licenses (12%), hardware (9%), and services (8%).
Oracle's cloud services and license support revenues grew year-over-year last quarter, but revenue from its other segments fell as macro headwinds throttled spending from its major enterprise customers. Its cloud expansion, which mainly focuses on migrating its on-premise databases to its cloud services, also faces tough competition from rivals like Amazon (AMZN +2.33%) Web Services.
Moreover, Oracle stopped reporting the growth of its individual cloud service units last year, which makes it tougher to gauge its turnaround efforts. Oracle's co-CEO Mark Hurd, who spearheaded Oracle's cloud transformation, also passed away earlier this year. Despite these challenges, Wall Street still expects Oracle's revenue to rise 1% this year and 2% next year as its strengths outweigh its weaknesses.
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Dividends, buybacks, and earnings growth
IBM pays a forward dividend yield of 4.8%, and it has raised its dividend annually for 24 straight years. If it hikes that payout again next year, it will become a Dividend Aristocrat -- an S&P 500 company that has raised its dividend for at least 25 straight years.
Oracle pays a lower forward yield of 1.8%, and it's only raised that dividend annually for seven straight years. Over the past 12 months, IBM and Oracle spent 46% and 25% of their free cash flow (FCF) on dividends, respectively. Both tech giants have plenty of room to raise their dividends, but Big Blue is clearly a better overall pick for income investors.
IBM spent $3.6 billion, or 29% of its FCF, on buybacks over the past 12 months. Oracle spent a whopping $25.1 billion, over 100% of its FCF, on buybacks during the same period. Oracle also authorized another $15 billion on buybacks earlier this year.
IBM dialed back its buybacks to conserve cash for its dividend and acquisitions, while Oracle repeatedly "bought" earnings beats with its big buybacks. That's why analysts expect Oracle's earnings to grow at a faster rate than IBM's, and why Oracle's stock looks slightly cheaper relative to its growth potential:
|
Estimated earnings growth |
Current FY |
Next FY |
Forward P/E |
|---|---|---|---|
|
IBM |
(7%) |
4% |
10 |
|
Oracle |
11% |
8% |
13 |
FY = Fiscal year. Source: Yahoo Finance, Dec. 26.
The winner: IBM
Oracle is still holding steady as it deals with Hurd's passing and competition from AWS, but its revenue growth is sluggish, its dividend is low, and it's too dependent on buybacks.
IBM still faces an uphill battle in the cloud market, but its leadership is stable, its expansion plans for Red Hat are clear, its buybacks are disciplined, and it pays a hefty dividend. I'm not a fan of either stock right now, but Big Blue is still a better overall investment than Oracle at these prices.
