The past several years haven't been kind to shares of longtime technology stalwarts Microsoft (NASDAQ: MSFT) and IBM (NYSE: IBM). In an industry where the only constant is change, Microsoft and IBM failed to recognize and react to the rise of some of the most important trends in technology today, an error that has put each company firmly in catch-up mode.
However, now that both companies have seen the errors in their ways and installed a plan to fix them, the first signs of new growth are appearing. So which of these tech laggards appears to be the more attractive buy today? Let's take a look.
Source: Microsoft.
Bull thesis: Microsoft
Although there's a case for buying Microsoft, in the interest of transparency, I don't agree with it. Still, capable investors need to understand the counter-argument to their investment theses, so let me lay out the argument in those terms.
Microsoft under the leadership of Satya Nadella has changed dramatically, in terms of strategy and execution, from the Steve Ballmer era. With this year's release of Windows 10, Microsoft has finally nailed an operating system that offers a seamless user experience across all computing form factors. Better yet, Microsoft has also revamped its devices strategy and finds itself today producing sleek, innovative devices that stand a strong chance of succeeding in the marketplace, as evidenced by its recent Surface Book and high-end Lumia smartphones.
To wit: Microsoft impressed investors with its surprise earnings beat last week. And although much of the performance was due to below-the-line moves such as stock buybacks, Microsoft did signal some compelling momentum in its cloud-computing segment and in deferred revenue from subscription services such as Office 365.The recent double-digit surge in its stock price hurts its bull thesis, but if Microsoft can full execute its turnaround strategy, there could be ample room for future gains.
Source: IBM
Bull thesis: IBM
Although their current business and investing narratives parallel each other, Microsoft and IBM sport valuations that are appreciably different, with IBM enjoying an edge over Microsoft in this department. Here's a quick snapshot of a few key valuation metrics.
| Stock |
P/E Ratio (TTM) |
Forward P/E Ratio |
EV/EBITDA |
Dividend Yield |
|---|---|---|---|---|
|
IBM |
9.9 |
9.5 |
7.9 |
3.60% |
|
Microsoft |
35.5 |
17.2 |
11.2 |
2.70% |
Source: Yahoo! Finance.
There are a few different explanations to reconcile this massive gap. Dusting off my college finance theory, I'd say IBM's lower valuation could suggest greater risk facing the company, or lower expectations of future growth in its business. However, comparing IBM's recent quarterly report with Microsoft's makes this meaningful difference between their valuations seem somewhat hard to justify.
On a constant currency basis, each company saw revenue contract slightly in the calendar year's third quarter. IBM's 15.4% contraction in its income from continuing operations is worse than Microsoft's 6.75% operating income decline, though Microsoft only beat its earnings through a combination of aggressively buying back shares and lowering its taxes paid.
Moreover, like Microsoft, IBM is beginning to see traction in several of its growth initiatives. Adjusting for currency affects, IBM's cloud business has increased more than 65% year to date, producing an impressive $9.4 billion in sales over the past 12 months. Also like Microsoft, IBM has a long way to go before it's entirely out of the woods, but the current doubt depressing its shares makes it the more compelling opportunity.
Winner: IBM
Both companies face serious, but navigable, uncertainties about the future of their businesses. Neither business is likely to go the way of the dodo in the short term, which gives long-term Foolish investors an opportunity to capitalize on the market's myopic short-term focus. While neither will ever enjoy the kind of past growth that made them some of the most successful investments on the markets, there's money left to be made for those who believe the companies' turnaround plans will pan out. However, IBM's valuation advantage makes it a more compelling buying opportunity today. It's just that cheap.
