Back in August, I compared IBM (IBM -8.97%) and Oracle (ORCL -1.30%), two aging tech companies that had both been expanding their higher-growth cloud businesses to offset the slower growth of their legacy businesses.
At the time, I favored IBM over Oracle for its higher yield, lower valuation, and growth opportunities under its new CEO, Arvind Krishna. But since then, IBM's stock has dipped about 4% while Oracle's stock rallied more than 25%.
Did I overlook some of Oracle's strengths, or will Big Blue bounce back next year and beat the database software provider? Let's take a fresh look at both companies to find out.
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Why did Oracle attract more bulls than IBM?
Oracle outperformed IBM this year for two main reasons: It generated stronger revenue growth and it aggressively repurchased its shares to boost its earnings per share. Oracle's revenue has risen year over year for two straight quarters, while IBM's revenue has fallen for three straight quarters.
The growth of Oracle's cloud applications, especially its Fusion and NetSuite ERP (enterprise resourcing planning) services, offset the slower growth of its on-premise software. IBM's cloud revenue is still rising, thanks to its takeover of Red Hat last year, but the ongoing declines at its IT services, business software, and hardware businesses throughout the pandemic are offsetting those gains.
Oracle spent billions of dollars buying back shares over the past two quarters, but IBM didn't repurchase any shares during the comparable period. At the end of their latest quarters, Oracle's number of outstanding shares declined nearly 9% year over year on a diluted basis, while IBM's number of outstanding shares actually rose by less than 1%.
How fast are Oracle and IBM growing?
Oracle's revenue dipped 1% in fiscal 2020, which ended on May 31, but its adjusted earnings grew 9% as it spent a whopping $19.2 billion on buybacks. In the first half of fiscal 2021, Oracle's revenue rose 2% year over year, as demand for its cloud services remained resilient through the pandemic. Its adjusted earnings rose 16% as it repurchased another $9 billion in shares.
Oracle expects its revenue to rise 2%-4% year over year in the third quarter, and its adjusted EPS to grow 13%-17%. Analysts expect its revenue to rise 3% and 13%, respectively, for the full year. They expect that momentum to continue next year with 3% revenue growth and 7% earnings growth.
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IBM's revenue declined 3% in fiscal 2019, which matches the calendar year, as its adjusted EPS fell 7%. It only repurchased $1.4 billion in shares throughout the year, compared to $4.4 billion in 2018, as it reserved more cash for its $34 billion takeover of Red Hat.
In the first nine months of fiscal 2020, IBM's revenue fell another 4% year over year as the mild growth of its cloud and cognitive software unit was erased by the weakness of its business services, technology services, and global financing divisions. It didn't buy back any shares during that period, and its adjusted earnings plunged 19%.
Analysts expect IBM's revenue and earnings to decline by 4% and 34%, respectively, this year. But next year, they expect its revenue and earnings to rise 1% and 38%, respectively, as the pandemic passes.
Oracle looks stronger, but IBM isn't down for the count
Both stocks look fundamentally cheap: Oracle trades at 15 times forward earnings and pays a forward dividend yield of 1.5%, while IBM trades at just 10 times forward earnings and pays a higher yield of 5.3%.
IBM might look like a cheaper income stock, but it faces more near-term challenges than Oracle. However, IBM plans to spin off its slower-growth IT services business at the end of 2021, then streamline the "new IBM" to focus on the growing hybrid cloud and AI markets. That move could breathe fresh life into both businesses -- but IBM's growth rates could remain anemic until that split finally happens.
The winner: Oracle
The last time I compared Oracle and IBM, I underestimated the former's ability to generate stable revenue growth while overestimating the latter's ability to grow its cloud-related businesses. I also criticized Oracle's heavy use of buybacks to boost its earnings.
But I was wrong. Oracle's path toward generating stable cloud growth was shorter than IBM's since its core business had fewer moving parts, and its buybacks were well-timed. I haven't lost faith in IBM yet, but Oracle will remain the better buy until Big Blue finally splits in two.
