The long-term slump of International Business Machines (IBM 0.41%) stock may have finally ended. Following the release of its fourth-quarter and full-year 2023 earnings, the stock price surged 9% higher in the next trading session. With that move, the stock trades at its highest point since 2013, and is closing in on the all-time high from that year.
A move into the cloud, as well as efforts to spin off underperforming businesses, have undoubtedly changed IBM's investment thesis. But the cloud stock is up by nearly 35% over the last year. Such gains could leave investors wondering if they missed the opportunity to buy.
IBM's transformation
As mentioned before, IBM stock peaked in 2013. And with the stock having missed the bull market of the 2010s, investors may have understandably lost interest in the tech giant.
However, IBM's lackluster performance eventually led to changes. Arvind Krishna, who headed IBM's cloud and cognitive software division, spearheaded a $34 billion takeover of Red Hat in 2019. Krishna became CEO the following year and embarked on a campaign to acquire numerous other cloud businesses. He also spun a slow-growing managed infrastructure business off into a separate company called Kyndryl.
As of the second quarter of 2023, IBM became the fifth-largest cloud infrastructure business, claiming about 3% of the market. Thanks to Red Hat, it also leads the way in hybrid cloud technology, an ecosystem allowing public and private clouds to work together seamlessly.
How its cloud gains affect IBM's stock
Since IBM has become increasingly recognized as a cloud company, the recent gains have changed the investment thesis. The company still pays an annual dividend of $6.64 per share, which has risen for 27 straight years. However, the dividend yield that topped 5% as recently as June has fallen to about 3.5%.
Also, the stock's earnings multiple had fallen below 10 early in the pandemic. Now the stock sells at a 23 P/E ratio. That comes in lower than Alphabet's 30 earnings multiple. Still, investors may balk at paying that when looking at IBM's growth. For all of the optimism, IBM reported $62 billion in revenue for 2023, a yearly gain of just 2%. Revenue grew 4% yearly in the most recent quarter.
The company experienced a more significant improvement in free cash flow, as it rose 20% to over $11 billion. Since dividend costs were just over $6 billion during that time, it bodes well for the company and its income investors.
Nonetheless, Alphabet's revenue surged 11% higher year over year in Q3, while Microsoft and Amazon reported double-digit year-over-year revenue growth in their most recent quarters. Considering IBM's much slower revenue growth, a lower P/E ratio may not necessarily be an advantage for the stock.
Are investors too late?
Given IBM's valuation, it is likely not too late to buy, but it may be too late to buy at a bargain. Admittedly, 23 is not a high P/E ratio for a cloud stock, and no other cloud stock delivers a 3.5% dividend yield.
Nonetheless, when considering IBM's 2% revenue growth for the year, some investors may be less willing to pay 23 times earnings. And while it looks like it has become a force in the cloud industry, its larger cloud peers appear to overshadow the company.
Such conditions make the prospects for further valuation expansion uncertain. While IBM could still beat the S&P 500 in 2024, one might find higher potential for returns in other cloud companies.
