Is IBM Stock a Buy Now?

IBM's (IBM -9.54%) stock dipped 4% during after-hours trading on July 18 following its second-quarter earnings release. The tech giant's revenue rose 9% year over year (16% on a constant-currency basis) to $15.5 billion, which beat analyst estimates by $360 million. Those growth rates exclude IBM's revenue from Kyndryl (KD -0.82%), which it spun off last November.

The company's adjusted earnings rose 43% to $2.31 per share, which also surpassed analyst expectations by $0.02. Those headline numbers looked solid, so why did Big Blue's stock turn red after the report? Let's dive deeper into the quarterly numbers to see if its stock is still worth buying.

Image source: Getty Images.

The "new" IBM's priorities

After spinning off Kyndryl, which housed its slow-growth managed infrastructure-services business, IBM restructured its business into four simpler business divisions: software, consulting, infrastructure, and financing. IBM initially offered these estimates for the three largest divisions:

Data source: IBM investor briefing.

IBM claimed it could grow its annual revenue by the mid-single digits and its free cash flow (FCF) by the high single digits from 2022 to 2024. It also told investors it could generate between $10 billion-$10.5 billion in FCF in 2022.

The company planned to accomplish that turnaround by expanding its hybrid cloud and artificial intelligence (AI) services. Instead of going toe to toe against public cloud giants like Amazon and Microsoft, IBM believed it could wedge its open-source solutions -- which are mainly powered by its subsidiary Red Hat -- between the public and private clouds.

Has IBM been keeping its promises?

During the first half of 2022, IBM generated 40% of its revenues from its software division, 32% from its consulting division, and 25% from the infrastructure division. The remaining 3% came from its financing division and other smaller businesses.

In terms of revenue growth, IBM's three largest businesses have all been roughly matching its initial projections over the past three quarters.

Data source: IBM. Year-over-year revenue growth.

However, IBM is still generating a lot of its software sales (five percentage points of year-over-year growth in the second quarter alone) from Kyndryl. That percentage could decline in the near future as IBM divests its remaining stake in Kyndryl, which already plans to seek out new software partners after fully parting ways with IBM.

In addition, most of IBM's pre-tax margins are still below its long-term projections. Its software margins are approaching its target of the "mid-20s" for 2022 -- but they aren't anywhere close to its long-term goal of "nearly 30%" -- and its consulting margins are well below its target in the low teens.

Data source: IBM.

The gross margins for the consulting and infrastructure segments also fell year over year in the first half of 2022. IBM attributed that decline to higher labor and component costs, which it's trying to offset with higher pricing. But during the conference call, CFO Jim Kavanaugh warned that those price hikes could take "some time to show up in our margin profile, especially in consulting."

Citing those challenges, IBM's exit from Russia, and currency headwinds from a strong dollar, Kavanaugh slightly reined in his full-year FCF forecast to about $10 billion. However, Kavanaugh still expects IBM to grow its revenues by the high mid-single digits for the full year.

IBM didn't offer any exact guidance for the full year, but analysts expect its revenue and earnings to grow 6% and 22%, respectively. In 2023, they expect the company's revenue and earnings to increase by 3% and 8%, respectively.

A cheap income play in a volatile market

IBM still faces a lot of challenges, but its spin-off of Kyndryl has given it a rare chance to reboot its aging business. It's too early to tell if it can fulfill its ambitious turnaround plans by the end of 2024, but its stock looks cheap at 14 times forward earnings. It also pays a generous dividend with a hefty forward yield of 4.7%, spending over 90% of its FCF on those payments in the first half of 2022.

As long as IBM doesn't completely drop the ball over the next few quarters, I'd expect its low valuation and high yield to make it a cheap income stock to buy as rising interest rates weigh down the broader tech sector.