Iconic IBM (IBM 0.53%) has been a symbol of the technology sector since the dawn of the computer age. When Microsoft (MSFT 1.22%) launched in the 1970s, it was the upstart. Today, both are venerable tech conglomerates compared to Amazon, the company that helped popularize the current cloud computing craze with its Amazon Web Services offering.
But in recent years it became clear to both that they needed to reinvent themselves to adapt to the changing times, and both followed Amazon's lead to pursue cloud computing services, a key battleground segment in the technology industry. So how are two of the most recognizable brands in tech faring in this rapidly evolving digital landscape, and which would make the better addition to your portfolio?
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Today's IBM
In July, IBM completed its acquisition of Red Hat, a company known for its widely used Linux-based, open-source cloud computing software, to bolster its position in that arena. Big Blue's revenues from this part of its business grew 11% in 2019.
Despite the acquisition, though, IBM's overall 2019 revenue declined by 3%. While revenues from its Cloud and Cognitive Software division, which includes Red Hat, grew from $22.2 billion in 2018 to $23.2 billion last year, poor performances by other divisions led to IBM's worst revenue outcome in the last five years, coming in at $77.1 billion compared to 2018's $79.6 billion.
On the bright side, annual net income grew from 2018's $8.7 billion to $9.4 billion. This resulted in impressive earnings per share of $10.57, a level that the company expects to maintain in 2020. IBM also generated free cash flow of $11.9 billion, and returned $7.1 billion to investors in the form of dividends and share repurchases. It has now increased dividends 24 consecutive years, putting it on the verge of becoming a Dividend Aristocrat.
Looking ahead, IBM is hanging its (red) hat on a hybrid cloud computing solution, which mixes off-site cloud services and on-premises servers. That strategy was reflected in the decision to replace outgoing CEO Ginni Rometty with the head of IBM's Cloud and Cognitive Software division, Arvind Krishna. Perhaps the new CEO, who takes over in April, will be able to rejuvenate the ailing tech titan, just as Satya Nadella did for Microsoft.
The compelling case for Microsoft
Speaking of which, Microsoft, like IBM, has benefited greatly from its cloud computing business: Azure holds the second-largest market share in cloud services, behind AWS. In its fiscal second quarter, which ended Dec. 31, Microsoft experienced double-digit percentage growth across many key metrics.
| GAAP Metric | Fiscal Q2 2020 | Fiscal Q2 2019 | Change |
|---|---|---|---|
| Revenue | $36.9 billion | $32.5 billion | 14% |
| Operating income | $13.9 billion | $10.3 billion | 35% |
| Net income | $11.6 billion | $8.4 billion | 38% |
| Earnings per share | $1.51 | $1.08 | 40% |
DATA SOURCE: MICROSOFT. GAAP = GENERALLY ACCEPTED ACCOUNTING PRINCIPLES.
It's 2019 revenue grew 13.9% over 2018 to $125.5 billion. Net income grew 137% to $39.2 billion, more than four times higher than IBM's. However, its EPS for the trailing 12 months was about half of IBM's at $5.74.
Microsoft's performance was driven in large part by Azure. Its revenues grew an amazing 62% in the fiscal second quarter, outpacing all other areas of Microsoft's business.
Cloud computing aside, the company's famed Office product suite continued to dominate in its niche, producing double-digit percentage growth in the quarter. Microsoft also operates the popular social media site for professionals, LinkedIn, which saw revenue increase 24% year over year. It owns Dynamics, a customer relationship management software platform that experienced 12% revenue growth.
In fact, Microsoft's gaming division, powered by its Xbox product, was the only area with declines in the quarter: revenue was down 11% due to consumers holding off purchases in anticipation of the company's next-generation gaming console, which is due to hit the market near the end of 2020.
The clear winner
Although Microsoft's shares trade at a higher valuation than IBM's -- more than double its price-to-earnings ratio, in fact -- Microsoft is clearly the better buy. It's firing on all cylinders; even its gaming unit will get a boost once the new Xbox debuts. During a period when IBM's revenues have been moribund, Microsoft enjoyed three consecutive years of double-digit percentage revenue growth.
Given that IBM's new CEO has yet to make his mark or stake out a strategy for a turnaround, it's unclear where IBM will go from here. But even the bright spot that is its cloud-computing business pales in comparison to the performance of Microsoft's Azure. With Microsoft enjoying a growth trajectory that shows no signs of slowing down, it walks away victorious in this battle of tech titans.
