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Better Buy: Apple vs. IBM

By Leo Sun - Apr 20, 2021 at 8:16AM

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Should you follow Warren Buffett's lead and dump IBM stock to buy Apple?

Apple (AAPL 1.62%) and IBM (IBM -0.05%) are two tech giants that have generated very different returns for investors over the past decade.

Apple's stock price has skyrocketed more than 1,000% as the iPhone has reshaped the mobile market. The iPad redefined tablet computers, the Apple Watch dominated the smartwatch market, and the company further expanded its hardware ecosystem with AirPods and HomePods. Apple also aggressively locked in its users with new subscription services like Apple Music, Apple TV+, and Apple Arcade.

Meanwhile, IBM's stock price has declined 20% as the company has desperately tried to grow its revenue again. It's tried to expand its higher-growth cloud businesses to offset its declining business software, hardware, and IT services revenue, but those efforts have produced inconsistent results. Big Blue has also struggled to compete against Amazon (AMZN 3.15%), Microsoft (MSFT 1.07%), and other cloud giants.

Apple CEO Tim Cook.

Image source: Apple.

The choice between Apple and IBM might seem like a simple one. Even Warren Buffett's Berkshire Hathaway sold its entire stake in IBM and accumulated a big position in Apple in recent years. But are investors overestimating Apple's growth, and underestimating IBM's turnaround efforts?

Apple's growth is accelerating

Apple's revenue and earnings grew 6% and 10%, respectively, in fiscal 2020, which ended last September. Its rising sales of Macs, iPads, Apple Watches, AirPods, and software services all offset a 3% drop in iPhone sales, which accounted for half of its full-year revenue.

In the first quarter of 2021, Apple's revenue rose 21% year over year to $111.4 billion as it launched the iPhone 12, its first family of 5G devices. Its iPhone sales jumped 17% as all its other segments generated double-digit sales growth. Its services revenue rose 24% as it locked in over 600 million paid subscribers across its entire software ecosystem.

Apple's sales also hit record highs across all its geographic regions, led by its 57% growth in Greater China. Its gross margin expanded, it bought back $24.8 billion in shares, and its earnings per share jumped 35%.

Most analysts expect Apple to post its strongest year of iPhone sales since the iPhone 6 in 2014. However, Apple also faces unresolved conflicts over its app store fees, and it clashes with online advertisers over its privacy changes in iOS 14.

The Mac also faces fresh competition from Alphabet's Chromebooks, which outpaced MacBooks in full-year shipments for the first time in 2020, according to IDC. The expansion of its services ecosystem could also encounter fierce resistance from streaming media giants like Spotify and Netflix.

Despite the challenges, analysts expect Apple's revenue and earnings to grow 22% and 36%, respectively, this year as its strengths easily offset its potential weaknesses. Apple also ended the first quarter with nearly $196 billion in cash and equivalents, so it has plenty of ways to expand its business with fresh investments and acquisitions.

IBM will split into two companies

IBM's revenue and adjusted earnings declined 5% and 32%, respectively, in fiscal 2020, which aligns with the calendar year. Its total cloud revenue rose 19% to $25.1 billion, or 34% of its top line, but couldn't offset the soft demand for its legacy products and services throughout the crisis. Its gross margin expanded slightly, but its operating margin still declined.

A road sign showing a diverging road ahead.

Image source: Getty Images.

IBM's $34 billion acquisition of Red Hat, which it closed in mid-2019, didn't cushion the blow. Red Hat's revenue rose 18% in fiscal 2020, but postponed enterprise deals across IBM's other businesses wiped out those gains.

Analysts expect IBM's revenue to rise less than 1% this year as its growth stabilizes in a post-pandemic world, and for its earnings to grow 27%. However, those estimates don't fully account for IBM's planned split into two companies later this year.

CEO Arvind Krishna, who took the helm last April, plans to spin off IBM's slow-growth managed infrastructure services segment into a new company. The "new" IBM will then focus on expanding its higher-growth hybrid cloud and AI businesses with the support of Red Hat's open-source software.

Krishna believes IBM can carve out a niche in hybrid cloud services, which link public cloud platforms to private clouds, but Amazon and Microsoft are also expanding their public cloud platforms with hybrid cloud services.

IBM ended the year with $14.3 billion in cash on hand and marketable securities, which gives it some room for future cloud investments -- but it's still shouldering $61.5 billion in total debt, and $7.2 billion of that total matures within the year.

Apple reported $107 billion in long-term debt last quarter, but its cash and equivalents still easily outweigh that debt -- and just $7.8 billion of its total debt matures within the year.

It's still an easy choice

Apple trades at 29 times forward earnings and pays a forward yield of just 0.6% on its dividend. IBM has a much lower forward P/E ratio of 11, and pays a much higher dividend yield of 4.9%. IBM might initially seem like a bargain, but it's cheap because it faces too many unpredictable headwinds.

Meanwhile, Apple's valuation remains reasonable relative to its growth, and its path forward is much clearer. Therefore, I believe Apple will continue to outperform IBM for the foreseeable future.

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Stocks Mentioned

Apple Inc. Stock Quote
Apple Inc.
AAPL
$138.93 (1.62%) $2.21
International Business Machines Corporation Stock Quote
International Business Machines Corporation
IBM
$141.12 (-0.05%) $0.07
Microsoft Corporation Stock Quote
Microsoft Corporation
MSFT
$259.58 (1.07%) $2.75
Amazon.com, Inc. Stock Quote
Amazon.com, Inc.
AMZN
$109.56 (3.15%) $3.35

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

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