IBM CEO Arvind Krishna speaks at an IBM facility in Poughkeepsie, Recent York, on Oct. 6, 2022. IBM announced $20 billion in investments during President Biden’s visit that can go toward research and development and the manufacturing of semiconductors, mainframe technology, artificial intelligence and quantum computing within the Hudson Valley.
Dana Ullman | Bloomberg | Getty Images
IBM is not often described as a hot company. But in a 12 months that saw investors abandon all major tech stocks, Big Blue was within the green.
The Nasdaq is closing out its worst 12 months since 2008. High gas prices, soaring inflation and the Federal Reserve’s regular pace of rate increases have punished growth stocks and favored more mature, less volatile names which are viewed as more recession-resistant.
Tech names that thrived through the Covid days suffered essentially the most because the economy reopened and consumers returned to a lot of their old habits.
Amongst U.S. tech firms valued at $50 billion or more, IBM was one in every of only two to generate positive returns in 2022. As of Friday’s close, the stock was up 6% for the 12 months. The opposite gainer is VMware, which is up 5% since it agreed in May to be acquired by Broadcom for $61 billion.
While Meta, Amazon and Tesla have been pummeled, investors turned to 111-year-old IBM, betting on its stable earnings, alongside energy stocks equivalent to Exxon Mobil, health-care names including Merck and industrials Northrop Grumman and Lockheed Martin.
IBM beats Big Tech in 2022
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IBM is “trading well above its historical range,” Bernstein Research analysts wrote in a Dec. 20 note to clients. The firm has a hold rating on the stock.
No one will mistake IBM for a growth stock. Expansion is consistently in the one digits, and last 12 months the corporate spun off Kyndryl, its managed infrastructure services business, right into a separate publicly traded entity. That cut head count by about 90,000.
But IBM generated $752 million in free money flow in the newest quarter, up 25% from a 12 months earlier, and paid out $1.5 billion in dividends. Third-quarter earnings and revenue each topped estimates, and the corporate raised its forecast for the complete 12 months.
Crawford Investment Counsel in Atlanta, which focuses on income and dividends, checked out IBM in 2016 and concluded that it might be too early for a significant investment, said Aaron Foresman, an equity analyst on the firm.
‘Much closer to their vision’
Crawford’s thesis modified in 2019, after IBM bought faster-growing Red Hat for $34 billion. The firm, which today has $6.7 billion under management, boosted its IBM stake from $2 million to $30 million and kept buying until its holdings reached $109 million.
IBM took a hybrid approach to the cloud under CEO Arvind Krishna, who succeeded Ginni Rometty on the helm in 2020. After struggling to realize scale as a cloud infrastructure provider, the corporate bet that enterprises would use on-premises data center infrastructure in addition to the general public cloud, moderately than relying entirely on one approach or the opposite.
“Three years later, it’s much closer to their vision than all the things on public cloud,” Foresman said. His firm sold 3% of its shares within the second and third quarter of this 12 months.
Consulting stays an enormous a part of IBM’s business, accounting for one-third of revenue. In that realm, IBM partners with the massive cloud providers, moderately than strictly competing with them. The corporate has a backlog of business with Microsoft value greater than $1 billion, and an excellent larger one with Amazon, Krishna said in a conversation with RBC CEO Dave McKay in November.
IBM also made technological advances in 2022, introducing the z16 mainframe computer. When a recent mainframe hits, many purchasers upgrade. That results in greater hardware revenue and highly profitable transaction processing software to run on the machines. IBM’s prior mainframe boom cycle began in September 2019.
While IBM stayed away from any splashy high-priced acquisitions this 12 months, it announced some smaller deals to reinforce certain capabilities. Earlier this month, IBM agreed to purchase Octo, a consulting company based in Virginia that targets government agencies. Terms weren’t disclosed. It also absorbed consulting firms Dialexa and Sentaca this 12 months.
Foresman described the purchases as an appropriate use of capital and “so small that they don’t seem to be necessarily disclosing transaction multiples.”
Still, Krishna recognizes that the economic backdrop is not ideal. He said in October that higher prices have led to “some caution creeping into the conversations” in Europe, where the corporate has to arrange for a downturn. Within the Americas, where IBM gets about 53% of revenue, the business climate is “very robust,” he said.
The Bernstein analysts said the stock’s direction from here might simply ride on the state of the economy, moderately than any major catalyst contained in the company.
“Given its defensive characteristics and historical performance, we imagine that IBM is more likely to fare well if we proceed to have pressured markets, and more likely to lag major indices if we enter a recovery period,” they wrote.
IBM’s model through 2024 calls for mid-single-digit revenue growth, translating into free money flow growth within the high single digits.
That is adequate for investors who search for safety of their equity bets.
“Combined with mid-single-digit revenue growth, a pair points higher than that on EPS and a 5% dividend yield is — you recognize, that is not a house run, nevertheless it’s well inside our expectations for what we’re trying to perform,” Foresman said.
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