Please ensure Javascript is enabled for purposes of website accessibility

Is IBM Stock a Buy?

By Herve Blandin - Jan 27, 2021 at 7:15AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

After disappointing fourth-quarter results, management expects revenue growth in 2021 and beyond.

International Business Machines' (IBM 1.07%) has focused more on its growth businesses, such as cloud computing and artificial intelligence (AI), in recent years. Yet, that focus adjustment has yet to translate into strong quarterly results. During the tech giant's fourth-quarter earnings call last week, management again expressed confidence in increasing revenue and free cash flow over the next two years. Stock trading on the day earnings were released though suggests the market is skeptical.

Considering the company's current low valuation and the challenging transformation it has set for itself, is IBM stock a buy?

Yet another challenging quarter

Over the last several years, Big Blue has been struggling to offset the decline of its large legacy business segments (on-premises software, hardware, and services for enterprises).

IBM Revenue (TTM) Chart

IBM Revenue (TTM) data by YCharts

The fourth quarter was no exception. Adjusted for divestitures and at constant currency, revenue declined 8% year over year to $20.4 billion. During the earnings call, CEO Arvind Krishna justified this underwhelming performance with customers delaying projects and signing shorter service engagements amid economic uncertainty. In addition, the planned spinoff of IBM's legacy consultancy activities led to longer negotiations that postponed some deals.

The company's cloud businesses kept generating solid results, though. For instance, the cloud specialist Red Hat, acquired by IBM in 2019 for $34 billion, grew 18% year over year on a normalized basis in 2020. And the number of customers that use IBM's hybrid cloud platform, which allows applications to run on private and public clouds, increased by 40% year over year to 2,800.

More generally, revenue from cloud increased 8% year over year (at constant currency) to $7.5 billion and represented 37% of total revenue during the fourth quarter, up from 31% of the total in the prior-year period.

Cloud icon in computer data center hallway

Image source: Getty Images.

A brighter future thanks to hybrid clouds

As a growing part of IBM's revenue, cloud activities should increasingly contribute to the company's top-line performance. And management has been investing to fuel that growth thanks to the company's strong free cash flow of $10.8 billion over the last 12 months.

As an illustration, since Krishna took over in April 2020, the company announced 10 acquisitions to strengthen its hybrid cloud and AI portfolio and services. For instance, Red Hat signed a definitive agreement at the beginning of the year to acquire the security specialist StackRox and enhance its flagship hybrid cloud platform OpenShift with cloud-native security capabilities. 

Investments in the hybrid cloud area have become key to IBM's transformation. Indeed, management estimates the hybrid cloud market at $1 trillion, and with relevant acquisitions and internal developments, IBM can leverage and enhance its software and services offerings to address that significant opportunity (fewer than 25% of workloads have been moved to the cloud so far).

Low valuation

Strong execution should lead to improving performance by the second half of the year. And with operating leverage, increasing free cash flow should fund the company's ambitions in investing in hybrid cloud and AI opportunities, sustaining its dividend, and reducing its debt load. 

So management expects adjusted free cash flow to reach between $11 billion and $12 billion in 2021, and between $12 billion and $13 billion in 2022. Adjusted free cash flow over the next two years will depend on the timing of cash tax items, and it excludes reorganization expenses. But if you consider $11 billion of annual free cash flow going forward, IBM stock looks cheap at less than 10 times that estimated free cash flow.

Granted, besides the operational risks, the reorganization of the company, which includes the spinoff of its legacy consulting business and the simplification of its go-to-market model, will lead to significant exceptional expenses of approximately $4 billion over the next 18 months.

Yet investors should consider IBM as an attractive tech stock. In contrast to some high-growth tech specialists, the company won't generate spectacular results over the next few years, but its valuation corresponds to low expectations -- no growth -- despite increasing exposure to the promising hybrid cloud and AI markets.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

International Business Machines Corporation Stock Quote
International Business Machines Corporation
$135.03 (1.07%) $1.43

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning service.

Stock Advisor Returns
S&P 500 Returns

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 05/17/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.