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Who had International Business Machines (IBM -0.12%) outperforming all other large-cap tech stocks on their 2022 bingo cards? While tech stocks have generally been a disaster this year, century-old IBM has delivered a market-beating performance for investors.
IBM data by YCharts.
From its pandemic low in early 2020, IBM stock is now up more than 50%. The stock has been slowly gaining ground since bottoming out, while other tech stocks have soared, only to crash spectacularly, wiping out pandemic-era gains.
While IBM has been a top performer this year, investors can still buy the stock at a reasonable price.
IBM has been working on transforming itself for nearly a decade. The company has ditched legacy businesses where it had no meaningful competitive advantages, invested in cloud computing, doled out $34 billion for software company Red Hat to strengthen its cloud computing hand, and spun off its massive managed infrastructure-services business.
IBM is much smaller than it once was, but the company’s product portfolio is now skewed toward higher-value hardware, software, and services. More than 70% of IBM’s revenue now comes from software and consulting, and hybrid cloud-related revenue has reached $22.2 billion over the past 12 months.
IBM’s mainframe business continues to chug along, with whole industries dependent on the hulking systems. Around 90% of the world’s top 50 banks still run on IBM mainframes.
Based on IBM’s latest results, the company may have finally found its groove. Revenue jumped 15% year over year in the third quarter, adjusted for currency, and the company is on track to deliver solid revenue growth this year along with around $10 billion of free cash flow. While a recession next year may create some headwinds for IBM, the company should otherwise be able to deliver sustainable revenue growth from here on out.
With a market capitalization of about $127 billion, IBM stock trades for less than 13 times its free-cash-flow guidance. Based on the average analyst estimate for 2023 earnings, the stock trades at a price-to-earnings ratio below 15.
IBM is aiming to deliver mid-single-digit revenue growth and high-single-digit free-cash-flow growth through 2024. Much of that growth will be driven by software and consulting, while the hardware business should remain roughly flat, adjusted for product cycles. Because IBM is shifting toward software, there’s plenty of room for margin expansion over time.
One thing worth noting is that IBM has a significant amount of debt. Total corporate debt, which excludes debt tied to the financing businesses, stood at $39.7 billion at the end of the third quarter. The company essentially stopped buying back its own shares following the Red Hat deal and its dividend already eats up around $6 billion annually. In other words, investors shouldn’t expect a significant increase in the dividend or a restart of the share-buyback program until free cash flow rises.
Speaking of the dividend, IBM offers a generous one. A quarterly per-share payment of $1.65 works out to a dividend yield of about 4.7%. The dividend has been increasing very slowly since 2020, and that trend will likely continue for now. Still, IBM’s dividend yield is more than double that of the S&P 500‘s.
IBM stock isn’t going to 10x anytime soon, but the company seems to have finally positioned itself to grow revenue and free cash flow consistently as it taps into demand for hybrid-cloud computing. With IBM’s solid dividend and attractive valuation, 2023 may be an even better year for the company’s stock.
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to Meta Platforms CEO Mark Zuckerberg, is a member of The Motley Fool’s board of directors. Timothy Green has positions in International Business Machines. The Motley Fool has positions in and recommends Alphabet, Amazon.com, Apple, Meta Platforms, Microsoft, and Salesforce. The Motley Fool recommends the following options: long March 2023 $120 calls on Apple and short March 2023 $130 calls on Apple. The Motley Fool has a disclosure policy.
*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.
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