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Better Buy: Apple vs. IBM

By Will Healy – Sep 2, 2020 at 8:47AM

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Should investors bite into Apple or take a chance on Big Blue?

Apple (AAPL -0.74%) and International Business Machines (IBM 0.61%) are established tech companies on opposite ends of the spectrum. One has attained the largest market cap in the U.S., and the other has remained a force in the tech industry for more than a century.

However, Apple has become a significantly more expensive stock, particularly since its market cap has moved past the $2.25 trillion mark as of the time of this writing. At a market cap of just over $110 billion, Big Blue suddenly does not seem so large. Nonetheless, with new leadership and recent successes in the cloud, it may begin to make a long-awaited comeback. Let's look at both companies to see which might make for the better investment.

Where Apple stands

Admittedly, Apple's balance sheet may make it seem like a slam dunk at first glance. The company holds more than $193.6 billion in available liquidity. With this position, few companies can match Apple for either balance sheet stability or flexibility.

Businessman connecting to data through the cloud on his computer.

Image source: Getty Images

The company hardly needs its cash reserves to bail itself out. Apple benefited from a blowout quarter as COVID-19 led to a surge in product sales. Revenue rose by 11% year over year. All categories, except the iPhone, which will probably benefit from an upcoming 5G release later this year, experienced double-digit percentage increases. Earnings per share (EPS) surged by 18% during the same period.

This had led to the stock price rising by almost 70% year to date. The stock has seen so much growth that Apple recently announced a four-for-one stock split. Analysts expect the success to continue as they forecast approximately 9% earnings growth for this year and nearly 20% next year.

AAPL Chart

AAPL data by YCharts

Most of the negatives of Apple stock relate to it becoming a victim of its success. Thanks to the surge, the forward price-to-earnings (P/E) ratio has risen to just above 33, more than double the five-year average forward multiple of around 15.7. Moreover, dividends are at $3.28 per share pre-split, a yield of less than 0.7%. This is well under the S&P 500 average of about 1.7%.

Furthermore, at about a $2.25 trillion market cap, it will have to reach a $4.5 trillion market cap for the stock to double in value. Even for a stock like Apple, this is a tall order.

The state of IBM

IBM stock would have to double in value multiple times to have a similar issue. However, IBM does not come close to matching Apple in balance sheet strength. Though it holds just over $12 billion in cash, it massively increased its debt load on the $34 billion acquisition of Red Hat.

Although long-term debt is below its peak, it still amounts to more than $55.5 billion. This is a heavy burden for a company with just under $20.6 billion in stockholders' equity, the amount of value left after subtracting liabilities from assets. Moreover, revenue fell by 5.4%, while adjusted earnings dropped by 31%.

IBM has long remained in decline, so much so that the stock has not only fallen by about 7% year to date but has also dropped by over 22% over the last five years.

IBM Chart

IBM data by YCharts

Indeed, the pandemic exacerbated some of these declines as demand for business services, technology services, and financing fell. These offerings had also seen falling demand before the pandemic, so lower economic activity appears to have worsened the declines. As a result, analysts forecast a drop in earnings of over 13%, followed by a resurgence of more than 10% in fiscal 2021.

However, the company has made changes that give bulls a reason for optimism. IBM elevated the head of its cloud division to the CEO position in April. Moreover, even as revenue declined, total cloud revenue rose by 30% year over year. Since Microsoft also appointed its cloud head to the CEO position six years ago, one might compare IBM today to Microsoft in 2014. Although one cannot say for sure that IBM will match Microsoft's growth, it has placed itself on a similar path in the cloud industry.

Furthermore, IBM sells for just over 11 times forward earnings, well under the S&P 500 average current multiple of almost 30. Additionally, its annual dividend of $6.52 per share, which just experienced its 25th consecutive yearly increase this year, yields almost 5.25%. This gives new buyers significant cash flow at a low cost.

Apple or IBM?

Admittedly, investors have a strong speculative case for buying IBM. The low forward P/E ratio and the high dividend yield offer prospective stockholders an incentive to buy. Moreover, IBM could potentially establish itself as a major player in the cloud.

However, if one bases the decision on known factors, Apple is more likely to outperform its tech counterpart. The company's liquidity position places it in control of its destiny. Moreover, the coming 5G upgrade cycle and the interest in its other products means double-digit increases will likely continue for the foreseeable future. This gives Apple the likely growth that IBM has not attained, at least for now.

Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool's board of directors. Will Healy owns shares of IBM. The Motley Fool owns shares of and recommends Apple and Microsoft and recommends the following options: long January 2021 $85 calls on Microsoft and short January 2021 $115 calls on Microsoft. The Motley Fool has a disclosure policy.

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