It's hard to imagine a big tech stock more down on its luck than International Business Machines (NYSE:IBM). While the Nasdaq index is up 28.4% on the year, IBM is down 17.5% as of this writing. Of course, this isn't a new story. The switch to cloud computing has led to headwinds in IBM's on-premises IT management services for years.
However, for value investors looking for a contrarian bet, IBM may be worth a look. The company's new CEO Arvind Krishna just took over the top job in April and recently announced a spinoff of IBM's slower-growth IT services business to refocus on its hybrid cloud and artificial intelligence technology. Following its earnings report, the company hiked its dividend, which now yields 6%. Of course, IBM is just a little over a year into its massive $34 billion acquisition of Red Hat last July.
In fact, earlier this week, three different insiders decided to buy up a significant amount of IBM shares in the open market. Should you follow?
On Tuesday, Oct. 27, director Sidney Taurel purchased a whopping 5,000 shares of IBM at $110.75 for $554,000. Half a million dollars is a significant purchase that increased his holdings by 21%. Taurel was followed by a $1 million buy-in from director William Frederick McNabb III, marking his first ownership of the stock, as well as a $107,000 purchase from director Frederick Waddell that increased his holdings by 36.2%.
Notably, McNabb -- who just joined IBM's board in 2019 -- is the retired Chairman and CEO of the Vanguard Group, which is a big proponent of holding index funds over individual stocks. The fact that he purchased $1 million worth of an individual stock, let alone IBM, certainly says something.
Meanwhile, Waddell is the retired CEO of Northern Trust, and has been a director since 2017. Taurel is Chairman Emeritus of Eli Lilly (NYSE:LLY) and has been an IBM director since 2001.
What they may be seeing
IBM's stock is down since it reported earnings on Oct. 19. The company's revenue fell 2.6% last quarter, but earnings per share actually increased from $1.87 a year ago to $1.89, as IBM was able to expand margins from cost-savings during the pandemic. That's not great, but certainly not bad. IBM's cloud and cognitive services revenue, which is the company's largest segment at 32% of revenue, is growing. That segment, which includes Red Hat, grew 6.8%.
IBM is no doubt very cheap, with a price-to-earnings ratio of 12.3, but an even cheaper nine times cash flow multiple. While IBM isn't exactly a growth business right now, if its newer hybrid cloud products catch on and revenue and profits stabilize, its bargain-basement valuation could still lead to significant upside.
Furthermore, it's possible these three directors think the proposed spinoff of its IBM's services business could lead to a meaningful rerating of each unit's valuation multiple. For instance, consulting "pure play" Accenture (NYSE:ACN) trades at a price-to-earnings ratio in the high 20s, despite its revenue declining 2% last quarter.
Meanwhile, if the remaining hybrid technology stack assets within IBM can find their way to growth, the "remaining" company could also get rerated to more of a software multiple, rather than the value multiple at which the company trades at today.
A word of caution
While IBM certainly looks like a promising value stock today -- what with its potential catalyst in the upcoming spinoff -- it should be noted that the market is currently valuing growth stocks much higher than those with stagnant or declining revenues. That gap is extremely wide now, and growth's outperformance has continued for an unprecedented amount of time.
Whether that trend reverses itself soon is impossible to say. However, for those looking for a high-dividend stock with upside potential, IBM's recent insider purchases sure make its cast-off stock look interesting, especially ahead of the spinoff.