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Shares of International Business Machines (IBM), better known as IBM, have managed to stay out of the limelight of the artificial intelligence (AI) revolution that is currently underway in the tech sector, with hypergrowth names like Nvidia (NVDA) dominating the storyline. Still, to underestimate IBM's prowess would be a mistake.
Established in 1896, the Armonk, NY-based company's stock has been quietly trading at 10-year highs over $200 per share, and has outperformed the S&P 500 Index ($SPX) in 2024 with a gain of 23.6% so far.
As an investor, should you load up on IBM shares now? Let's weigh the evidence to determine whether IBM is still a “Buy” at decade highs or not.
IBM Stock: The Bull Case
Dividend Yield: One strong argument for owning IBM stock is its dividend yield. The stock currently offers a dividend yield of 3.36%, which is higher than the tech sector median of 1.48%.
More specifically, when compared directly to its peers like Accenture (ACN) and Cognizant (CTSH), IBM's forward dividend yield is much more generous than Cognizant's 1.56% and Accenture's 1.52%.
Plus, the tech giant has been raising dividends for each of the past 24 years, and is on the brink of gaining entry into the coveted “Dividend Aristocrat” club. And with a payout ratio of 65.32%, further growth in IBM's dividends should be sustainable.
Robust Fundamentals: IBM's consistency in terms of dividend payments can be attributed to its solid balance sheet. The company closed the latest quarter with a cash and equivalents balance of $16 billion, up by $2.5 billion from the start of the year. Concurrently, short-term debt levels shrank substantially to $3.6 billion from $6.4 billion at the end of 2023.
In its results for the latest quarter, IBM beat analysts' expectations on both revenue and earnings. Revenues for the second quarter came in at $15.77 billion, up 1.9% from the prior year. Adjusted EPS jumped by 11.5% on a YoY basis to $2.43, comfortably surpassing consensus estimates. Notably, this marked the 11th consecutive quarter where IBM's EPS outpaced the average analyst estimate.
During Q2, the company reporting that net cash from operating activities fell slightly year over year to $2.1 billion. Free cash flows, however, increased to $2.6 billion in the quarter, and IBM reported $4.5 billion in free cash flow for the first half of the year. For the full year, management raised its guidance to call for free cash flow above $12 billion.
Strategic AI Initiatives: Supported by its strong balance sheet, IBM is making significant strides in the AI space with a clear focus on enterprise solutions. To overcome challenges related to data privacy that hinder widespread AI adoption, the company’s WatsonX AI platform and the Granite family of models offer promising solutions. IBM Consulting further enhances its AI initiatives by integrating services with a library of role-based AI assistants, allowing for enterprise-level customization.
IBM's momentum in AI is evident, with generative AI bookings doubling from $1 billion in the first quarter to $2 billion in the second quarter. Additionally, IBM's partnership with Facebook parent Meta (META), established a year ago, is beginning to yield results. Leveraging its expertise in delivering customizable AI solutions, IBM plays a key role in the launch of Meta's Llama 3.1 model, particularly the 405 billion parameter variant. In this collaboration, IBM is responsible for tailoring, modifying, and implementing the models developed by Meta.
IBM has also established partnerships with Amazon (AMZN), Adobe (ADBE), and Microsoft (MSFT). These developments position IBM as a leader in AI, combining its strengths in consulting, software solutions, and AI development. This makes the company an ideal partner for enterprises navigating AI adoption while ensuring compliance with stringent data regulations.
Quantum Computing Prowess: IBM's journey in quantum computing has been marked by both achievements and challenges. As the first commercial company to develop quantum technology on a large scale, IBM has made significant strides in the field. Its quantum computing platform, Qiskit, is tailored for companies looking to code and implement quantum computing software.
Additionally, IBM boasts the largest operational quantum computer, known as Condor.
Attractive Valuation: Despite its outperformance on the charts this year, IBM stock is trading at reasonable valuations when compared to the rest of the tech sector. The stock is priced at a forward price/earnings (P/E) ratio of 19.59, a discount to the sector median of 23.77x. Likewise, the price/cash flow (P/CF) ratio for IBM is 13.59, about 38% cheaper than the median tech valuation.
IBM Stock: The Bear Case
Tepid Growth Forecasts: It's worth considering IBM's apparently low valuation in the context of its expected growth. For example, analysts are projecting IBM to manage forward revenue growth of just 3%, which is less than half the tech sector median forecast of 6.5%. While Wall Street may yet be undervaluing the company's ability to deliver AI growth, this possible cause for concern is reflected in IBM's relatively steep price/earnings-to-growth (PEG) ratio of 3.94.
Rising Debt: IBM's long-term debt levels are much higher than its cash balance. Although this hasn't been an issue for IBM as of yet, a rise in long-term debt levels increases the interest burden and puts a dent in the profitability of the company. At the end of the second quarter, the company's long-term debt stood at a mammoth $52.93 billion, which is almost 30% of its total market cap. Moreover, this rose from $50.12 billion at the start of the year.
Cloud Competition and Other Headwinds: IBM's acquisition of Red Hat in 2019 was supposed to propel the company to be a serious cloud player. However, that has not been the case, and IBM has been able to corner a mere 2% market share in the intervening years, with Amazon's AWS and Microsoft's Azure continuing to dominate the market.
Also, IBM's consulting business slowdown is worth watching, with revenues for the segment declining 1% in Q2 2024.
What's the Analyst Verdict on IBM?
Considering this, it's not surprising to find that analysts have an average rating of “Hold” for IBM stock. Out of 15 analysts in coverage, 4 have a “Strong Buy” rating, 1 has a “Moderate Buy” rating, 8 have a “Hold,” and 2 have a “Strong Sell.”
IBM has already surpassed its mean price target of $188.47. The Street-high target price is $220, which denotes an upside potential of about 8.8% from Friday's close.
On the date of publication, Pathikrit Bose did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
