IBM (IBM 0.58%) and Alphabet (GOOG 0.56%) (GOOGL 0.42%), the parent company of Google, aren't frequently compared with one another. IBM is a mature tech stock which is generally owned for stability and income, while Alphabet has been a growth stock ever since its IPO in 2004.
Yet IBM and Alphabet's businesses still overlap in many markets, including cloud computing and artificial intelligence. Google also integrates IBM's Power Systems into the Google Cloud for enterprise customers.
Alphabet was clearly a better investment than IBM over the past ten years, as its 430% rally crushed IBM's total return of just over 50%. But past performance doesn't guarantee future gains, and IBM seems to have turned a corner over the past year as Alphabet lost momentum. Let's take a fresh look at both tech giants to determine which stock is the better overall investment for 2020.
Image source: Getty Images.
How do IBM and Alphabet make money?
IBM splits its business into five main units: cloud and cognitive software (33% of its revenue last quarter), global technology services (32%), global business services (19%), systems (14%), and global financing (1%).
The cloud and cognitive software unit houses various cloud, security, and IoT (Internet of Things) services, as well as Red Hat, the open-source software maker it acquired for $34 billion last year. The global technology services unit houses its core IBM Cloud infrastructure business, which competes against larger platforms like Amazon (AMZN 0.87%) Web Services (AWS), Microsoft's (MSFT 1.57%) Azure, and Google Cloud.
Its global business services unit offers IT and consulting services, its systems business sells mainframes and storage systems, and its financing unit provides various financing options for enterprise customers.
Alphabet generated 83% of its revenue from Google's advertising business last quarter. 6% came from its cloud business, 11% came from other businesses like hardware devices, and less than 0.4% came from "other bets" like driverless cars and healthcare initiatives.
Which company is growing faster?
IBM has struggled with revenue declines over the past few years as the weakness of its legacy businesses overwhelmed the growth of its newer cloud-oriented businesses. Meanwhile, Alphabet consistently generated double-digit revenue growth as the strength of its core search and advertising business offset the less predictable returns from its other businesses.
|
Revenue growth |
FY 2015 |
FY 2016 |
FY 2017 |
FY 2018 |
FY 2019 |
|---|---|---|---|---|---|
|
IBM |
(12%) |
(2%) |
(1%) |
1% |
(3%) |
|
Alphabet |
14% |
20% |
23% |
23% |
18% |
Source: Company annual reports.
IBM's revenue growth is constantly obfuscated by acquisitions, divestments, and currency headwinds. For example, if we exclude the impact of currency headwinds and divestments, its revenue would have stayed nearly flat in 2019.
Image source: IBM.
Looking ahead, IBM expects three main tailwinds to boost its revenue again: rising demand for its hybrid cloud services, its integration of Red Hat, and the cyclical recovery of its systems business. Arvind Krishna, the chief of IBM's cloud and cognitive Software unit, will also succeed Ginni Rometty as Big Blue's new CEO in April.
Wall Street expects these changes to boost IBM's revenue and earnings by 2% and 4%, respectively, this year. Those growth rates seem tepid, but they would represent a return to stable growth for the company. Moreover, its forward P/E of 10 and forward dividend yield of 4.4% should set a floor under the stock as its business recovers.
Alphabet's revenue growth decelerated in 2019 as demand for its ads declined amid tough macro headwinds and competition from rivals like Facebook (FB 3.77%). It was also scrutinized by regulators over the past year regarding anti-competitive strategies and controversial privacy practices. Sundar Pichai was notably promoted from Google's CEO to Alphabet's CEO last December, but the move didn't significantly change the company's strategies.
Analysts expect Alphabet's revenue to rise 18% this year with 10% earnings growth. However, investors should expect the company to ramp up its spending on fresh initiatives -- including the expansion of Google Cloud and the monetization of YouTube -- over the next few quarters. Alphabet's stock seems reasonably priced at 22 times forward earnings, but it doesn't pay a dividend, and its core advertising business remains exposed to macro headwinds.
The better buy: Alphabet
IBM and Alphabet are both solid tech stocks. However, Big Blue's turnaround plans remain speculative at this point, and it's still an underdog in the competitive cloud market. Alphabet faces plenty of headwinds, but its core advertising business should remain robust for the foreseeable future. Therefore, IBM is a decent investment for dividend investors, but Alphabet will likely outperform the aging tech giant again this year.
