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IBM Stock Very Well Could Be the Best Buy in Tech

IBM (NYSE:IBM) can’t get any respect. Despite strong and improving profitability, IBM stock has been a dog for almost twenty years now. Remember, it traded as high as $125/share in the early 2000s. More than 15 years later, it has only advanced to $150/share now.

Following the financial crisis, IBM appeared to prosper, with the stock reaching as high as $200 in 2012. Since then, it’s been a lost six years for the company, even as the stock market in general and tech shares in particular have soared.

What’s gone wrong for IBM, and is there a viable path to the stock recovering going forward?

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Struggling Business Outlook

IBM faces a simple yet persistent problem: its core business is slowly disappearing. IBM built a sterling reputation over the years in its primary enterprise IT market. The company was the one-stop shop for mainframes and big mission-critical computing tasks.

However, in 2018, that legacy market is less and less important. Nowadays, much of that activity is going to the cloud, where there are more nimble and respected competitors than IBM.

That said, IBM’s position isn’t actually as bad in the cloud as you might have heard. And the slump in revenues has finally ended, as IBM has showed revenue growth over the past few quarters for the first time since 2012. But IBM stock remains at a discount valuation nonetheless.

Dirt Cheap Stock

A couple years ago, a bunch of older generation tech companies, including the likes of Microsoft (NASDAQ:MSFT) and Intel (NASDAQ:INTC) had struggled for years along with IBM. They sold near 10x earnings and offered strong dividend yields.

Over time, the market discovered these companies, and transformed them from laggards to big winners. Microsoft in particular has had an amazing revival.

This transformation has not happened for IBM stock, yet. As such, IBM is arguably the cheapest large-cap tech stock on the market today. IBM sells at just 12x trailing and 10.5x forward earnings. That’s an incredible bargain in the year 2018. Or at least it would so seem.

Consider what a 10.5x forward earnings ratio means. IBM is generating an earnings yield of more than 9% annually. With no growth, the company is likely to produce 9%+ total returns from shareholders simply from running its business and paying out the profits to shareholders via the dividend and share repurchase program.

Any modicum of revenue growth or a higher PE ratio going forward would open a path to 15%+ total annual returns for IBM stock over the next few years.

Think about the math. IBM stock pays a more than 4% dividend yield at the current price. And the company buys back a ton of stock.

Dating back to 2004, IBM has retired at least 2% of its total shares outstanding each and every year. Many years, the buyback has neared 5% of the shares outstanding. Add that to the dividend, and shareholders are getting a high single digit return just from IBM’s capital return program alone.

Is IBM Merely Running In Place?

IBM’s management presents an optimistic view of the future. Despite the company’s inability to grow revenues in recent years, management shows off its strategic initiatives which seem to offer great promise. Yet IBM’s disclosure is so vague that it is hard to get an exact read on just how well things are going.

The company has suggested that its artificial intelligence project, Watson, is going to be a massive growth driver in the future. IBM generates all sorts of buzz for Watson with its potential uses across a wide range of industries.

Just in health care alone, Watson, if it lives up to the hype, could be a many billion dollar a year business. And yet, it’s hard to gauge how much IBM’s efforts in strategic investments such as Watson are actually working.

What we do know is that IBM’s cloud is up to ~$18 billion in trailing twelve month revenue. That’s a large figure, and indeed makes IBM a strong competitor in the cloud space against the likes of Microsoft and Amazon.com (NASDAQ:AMZN).

However, IBM needs more than $18 billion in cloud revenue growing at a 20% annual rate to make up for losses elsewhere. Overall revenues are down from a peak of $106 billion for 2012 to $81 billion over the past 12 months.

To be fair to IBM, revenues bottomed out at $80 billion in 2016 and $79 billion in 2017, with the past 12 months showing an uptick for the first time since 2012.

However, the company has a lot more to prove that things are finally turning around. After losing that much of its revenue base over the years, a couple percent rebound in sales during a booming economy is hardly inspiring.

IBM Stock Verdict

The investment thesis for IBM is quite simple. The company generates a truly massive amount of earnings and free cash flow. Especially compared to other big tech peers, IBM is easily the cheapest stock around on an earnings and dividend basis.

Management has not shown great competence in managing the evolution of its business model. However, at this price, IBM stock is bound to make people money unless IBM’s leaders totally lose the thread.

With the cloud effort going well and other strategic initiatives such as Watson still potentially game-changers, there is plenty here that could improve sentiment. Mark IBM stock back to just 15x earnings (hardly expensive), and it is a $200 stock again. Combine with that fat dividend, and Big Blue is a solid blue chip holding at this price.

At the time of this writing, Ian Bezek owned IBM stock and INTC stock.

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