Shares of IBM (IBM -0.86%) rose 3% during after-hours trading on Wednesday following its third-quarter report. The tech giant's revenue rose 6% year over year (15% in constant currency terms) to $14.1 billion, which beat analysts' estimates by $550 million. Its adjusted earnings dipped 2% to $1.81 per share, but still cleared the consensus forecast by a penny.

Does that earnings beat make IBM a safe stock to buy in this volatile market? Let's review Big Blue's growth over the past year, its progress toward its pre-spinoff promises, and its valuations.

An IT professional checks a server.

Image source: Getty Images.

A return to consistent revenue growth

IBM spun off its sluggish managed infrastructure services unit as Kyndryl Holdings (KD 0.17%) last November. It subsequently restructured its business around three simpler segments: software (40% of its revenue in the first nine months of 2021), consulting (33%), and infrastructure (25%). The remaining 2% came from its financing segment and other businesses.

Before spinning off Kyndryl, IBM told investors it could grow its software revenue at a mid-single-digit rate from 2022 to 2024. It also predicted its consulting revenue would rise by the high single digits, its infrastructure revenue would stay roughly flat, and its total revenue would rise at a mid-single-digit rate. This is what happened over the past four quarters:

Period

Q3 2022

Q2 2022

Q1 2022 

Q4 2021

Software revenue growth YOY

7%

6%

12%

8%

Consulting revenue growth YOY

5%

10%

13%

13%

Infrastructure revenue growth YOY (decline)

15%

19%

(2%)

2%

Total revenue growth YOY

6%

9%

8%

7%

Data source: IBM. YOY = Year-over-year.

It might initially seem like IBM's consulting segment is struggling to live up to its pre-spinoff expectations. But that slowdown can be mainly attributed to currency headwinds, which IBM had excluded from its midterm forecasts. On a constant currency basis, IBM's consulting revenue still improved 16% year over year in the third quarter. Its software revenue also rose 15%, its infrastructure revenue jumped 23%, and its total revenue increased 15%.

During the conference call, CEO Arvind Krishna attributed that robust growth to its low exposure to macro-sensitive markets like retail, and its high exposure to "mission-critical areas" that leveraged more automation and artificial-intelligence services. IBM's hybrid cloud revenue increased 15% (20% in constant currency terms) to $22.2 billion over the past 12 months as large companies continued to crunch the data that flowed between their private clouds and public cloud services.

Kyndryl's orders still accounted for about five percentage points of IBM's constant currency revenue growth during the quarter. That percentage should gradually decline as Kyndryl decouples from IBM and pursues more deals on its own.

But even if we exclude Kyndryl's business, IBM is still generating consistent revenue growth again -- which it had struggled to achieve for years before the spinoff. For the full year, IBM expects its revenue to grow "above its mid-single-digit model" on a constant currency basis, while analysts expect its revenue to rise 4% on a reported basis.

Its margins are still being squeezed

Before spinning off Kyndryl, IBM predicted its software business would generate a pre-tax profit margin of nearly 30% between 2022 and 2024. It expected its consulting and infrastructure segments to maintain pre-tax profit margins in the low teens and mid teens, respectively. But as the following chart illustrates, it's still falling short of those midterm goals.

Period

Q3 2022

Q2 2022

Q1 2022

Q4 2021

Software profit margin

22.5%

22.3%

19.7%

29%

Consulting profit margin

9.8%

7.1%

7.2%

9.2%

Infrastructure profit margin

8.3%

17.9%

6.2%

23.5%

Data source: IBM. Pre-tax basis.

Its consulting margins were squeezed by inflation and higher labor costs, while its infrastructure margins were reduced by higher component costs. However, analysts still expect its adjusted EPS to grow 17% this year.

To reflect those challenges, IBM already slightly reduced its full-year free cash flow (FCF) forecast in July to about $10 billion, down from a pre-spinoff range of $10 billion to $10.5 billion. But it maintained that target -- which would represent a $3 billion increase from 2021 -- during the third quarter. That stable FCF growth indicates IBM can still easily cover its dividends, which consumed $5.93 billion of its cash over the past 12 months. It currently pays a forward dividend yield of 5.4%, which makes it one of the highest-yielding blue chip tech stocks in the S&P 500.

IBM is still an undervalued income play

IBM's steady growth over the past year indicates that divesting Kyndryl was the right move. Under Krishna, who took the helm in April 2020 and orchestrated that daring spinoff, Big Blue finally looks more comparable to other reliable tech stalwarts like Oracle. It also looks a lot cheaper than many of its industry peers at just 12 times forward earnings.

I wasn't a fan of IBM before it spun off Kyndryl, but I think this slimmed-down version is an undervalued income play for patient investors. It won't blast off anytime soon, but it's a great safe-haven play for this tough bear market.