Five years ago, IBM (IBM -1.05%) was little more than a fading memory for most people. The end of the mainframe computer era and the rise of cloud computing left the aging company behind. The revenue decline that began all the way back in 2012 was still well underway as of 2019. Many investors left it for dead.
What a difference five years makes! While IBM is still much smaller than it was then -- as measured by sales as well as profits -- the future looks promising. The organization has finally figured out how to remain relevant.
The question is, however, where will IBM and its stock be five years from now?
Meet the new and improved IBM
Younger investors may not believe it, but there was a time when IBM was the world's biggest company. And rightfully so. It just happened to be in the right place at the right time with the right technology -- the early days of personal computers.
As technology always does, however, it evolved. Mainframes and even desktop and laptop computers peaked, giving way to wireless internet, cloud computing, and mobile ways of connecting to networks. IBM just didn't keep up.
A funny thing happened five years ago, though. IBM acquired cloud computing tech specialist Red Hat, thrusting the company into the then-gelling arena. Then, in 2020, the company took another big leap into the world of cloud computing. It named Arvind Krishna as its CEO. Krishna made no bones about his vision either, penning a letter to all employees shortly after he took the helm, asking them to maintain a "maniacal focus on our open hybrid cloud platform and AI capabilities."
And by and large, IBM's employees have done exactly that. Last year's hybrid cloud and artificial intelligence software platform revenue grew 5%, with Red Hat's piece of this business growing 7% year over year in the fourth quarter alone; its hybrid infrastructure arm experienced revenue growth of 7% year over year in Q4. Overall revenue improved a little more than 2% in 2023 despite economic turbulence that prompted some would-be customers to tighten their purse strings.
That's not enormous growth, but it's progress following fiscal progress in 2022 as well as comparable progress in 2021. Better still, this progress is trickling down to the bottom line. Last year's operating cash flow of $13.9 billion is $3.5 billion better than the prior year's figure, while free cash flow grew by $1.9 billion in 2023 to $11.2 billion.
IBM Revenue (Quarterly) data by YCharts.
All of a sudden, IBM is interesting again. Ditto for the stock.
It's all about the multiplier
If you've not taken a close look at IBM within the past five years, much has changed, including the business model itself. Although he didn't dive into the numerical details in January's fourth-quarter earnings call, IBM's CFO Jim Kavanaugh explained, "When we deploy $1 [worth of spending on hardware], we're looking for a multiplier of hardware, software services on top of that." In other words, the sale of one of its products drives the sale of other products and services.
Kavanaugh didn't offer updated specifics during Q4's conference call, but he has spoken about it before. Roughly a year ago, for instance, he noted that "for every dollar of platform spend, clients spend $3 to $5 in software, and $6 to $8 in services." Those numbers likely still apply today.
The company's results bear this idea out, too. Infrastructure is no longer its biggest profit center. IBM's consulting arm (services) is a bit bigger than hardware, and software is a much bigger business than consulting.
Image source: IBM's Q4-2023 investor report.
This matters -- maybe in a way few investors fully appreciate. Although profit margins on all of IBM's goods and services are strong, margins on software are huge at just under 80%. This is how the company's cash flow has grown so well when it seems like it shouldn't have.
Image source: IBM's Q4 2023 investor report.
The other critical element in IBM's new business model is that much of it is recurring. Many of IBM's software and consulting customers pay a monthly fee for ongoing access to these tools. The company's recurring revenue tally now stands at an annualized figure of $14.4 billion, up 7% from the year-ago comparison. Software sales make up the biggest piece of this recurring revenue number, too, which, of course, is also IBM's most profitable arm.
The point is that this new business model works. It's also "sticky" in the sense that once an organization plugs into an IBM platform, it's then difficult to wean that organization off of it.
Looking five years down the road
But what does this mean for the company and, by extension, for the stock going forward? All predictions should be taken with a grain of salt. Things can always change.
An analysis of the business dynamic and trends currently in place suggests IBM's future looks bright. The analyst community believes IBM's annual top line will swell to just under $78 billion by 2028 versus last year's $61.9 billion. Per-share profits are expected to grow from last year's $8.14 to $13.10 in 2027. That's roughly 5% annualized growth for both fiscal measures. And, given Mordor Intelligence's expectation that the global hybrid cloud computing market is set to grow at a yearly pace of 22% through 2029, there's little reason to think the market won't support at least that degree of growth from IBM.
The stock's price five years from now, however, is a tricky matter made even trickier by the fact that shares are currently trading slightly above the consensus target of $184.82. Just keep in mind that it's a one-year target; we're looking five years down the road. This simply means long-term-minded investors might want to wait for a modest pullback before taking the plunge. But, many true buy-and-hold investors will want to take that plunge sooner than later.
Although it's anything but a growth stock now, and its glory days are clearly all in the past, IBM is relevant again. It's also profitable -- and increasingly so -- supporting a dividend that's not only been paid every quarter for over a century but a dividend that's been raised every year for the past 28 years. While a pullback from the stock would push its dividend yield a little higher, even at its current yield of 3.6%, income-seeking newcomers would still be doing better than they might with other dividend-paying stocks.
If you're looking for a guess, though, IBM stock could arguably be worth $280 per share five years from now. That's an annualized capital appreciation of about 9%, not counting the upside of the dividend payments it's going to dish out in the meantime.
That's just a guess, of course, albeit one that seems to make sense.
