International Business Machines: Slow Growth and Elevated Valuation

International Business Machines (IBM) is a multinational technology corporation that sells computer hardware, middleware, software, hosting, and consulting services. The company was founded in 1911 and incorporated in New York.

I am neutral on International Business Machines as its strong intellectual property portfolio and attractive dividend yield are offset by its declining revenue and elevated valuation multiples. (See Analysts’ Top Stocks on TipRanks)

Strengths

IBM currently has operations in over 171 countries. It is also a leading research organization that holds the record for the highest number of annual patents generated in the United States by a business for 28 straight years.

IBM’s most important inventions include the IBM mainframe, ATM, hard disk drive, floppy disk, magnetic stripe card, SQL programming language, DRAM, UPC barcode, and the relational database.

IBM is one of the world’s largest employers, with a headcount of over 345,000 as of 2020. Over 70% of IBM employees are located outside the U.S., with India holding the largest employees.

Recent Results

IBM’s revenue for the third quarter of 2021 was $17.6 billion, showing an increase of 0.2%. The Cloud & Cognitive Software segment reported revenue of $5.7 billion, increasing 2.5%. Global Business Services segments posted total revenues of $4.4 billion, up 11.6%.

Global Technology Services showed revenue of $6.2 billion, a decrease of 4.8%. The Systems segment saw revenue of $1.1 billion, down 11.9%, and the Global Financing segment saw revenue of $220 million, decreasing 19.2%.

The company saw net cash from operating activities totaling $16.1 billion and an adjusted free cash flow of $11.1 billion, both showing an increase of $0.3 billion year-over-year. Total cloud revenue over a period of 12 months was $27.8 billion, an increase of 14%. Meanwhile, the company’s Red Hat revenue showed an increase of 17%.

IBM reported cash and marketable securities totaling $8.4 billion, a decrease of $5.9 billion from the year-end 2020, due to acquisition and payments for debts at the end of the third quarter. Debt has been reduced by $7 billion since the end of 2020.

Valuation Metrics

IBM stock looks a tad pricey here as its forward enterprise-value-to-EBITDA ratio is 9.5x compared to its five-year average of 8.9x, and its price-to-normalized-earnings ratio is 12.4x compared to its five-year average of 11x.

In addition, revenue growth has been negative for years and is expected to remain negative for the foreseeable future. Normalized earnings per share took a large hit in 2019 and 2020, and, while expected to rebound nicely in 2021 and 2022, will still remain well below 2019 levels.

Wall Street’s Take

Turning to Wall Street, IBM earns a Moderate Buy consensus rating based on six Buys and three Hold ratings assigned in the past three months. Additionally, the average International Business Machines price target of $155.16 puts the upside potential at 19%.

Summary and Conclusion

IBM is a slow-growth stalwart that has been paying out a rising dividend for years. However, while it does possess a massive intellectual property library that helps to provide a moat around its existing earnings, it has been outcompeted by other tech giants and is now facing a shrinking piece of the pie in an industry it once dominated.

Meanwhile, the valuation multiple looks elevated relative to its recent history even as revenue and EBITDA are expected to decline in the coming years and normalized earnings per share remain well below 2019 levels. As a result, investors might want to wait for a pullback before adding shares.

Disclosure: At the time of publication, Samuel Smith did not have a position in any of the securities mentioned in this article.

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