Beaten Down IBM Is Poised for Major Gains

Long-time unfavored Dow stock International Business Machines Corp. (IBM) has been picking up momentum over the past few months, rising more than 9% since the middle of the year, a few percentage points ahead of the broader market. While there is still much to dislike about IBM, whose shriveling revenues over recent years has some analysts calling for further declines, some analysts are predicting a turnaround in revenues as the company focuses on higher-margin business segments, including cloud computing, analytics and security. With a view that the stock is currently undervalued, UBS analyst John Roy upgraded the stock to a buy rating and lifted his price target to $180, implying an upside of 20%, according to Barron’s.

Bullish Forecast for IBM

Source: CNN Money, as of Thursday, Oct. 4, 2018

Why It Matters to Investors

Based solely on the company’s forward earnings and dividends relative to the price of its shares, there’s no doubt the stock looks undervalued. At a forward price to earnings ratio (P/E ratio) of 10.75, IBM is currently trading well below the S&P 500’s forward multiple of 18.09 and the Dow Industrial’s forward multiple of 17.11. Meanwhile, its trailing annual dividend yield is 3.96% compared to 1.98% for the S&P 500 and 2.25% for the Dow Industrial. IBM is trading at a forward annual dividend yield of 4.14%. (To read more, see: IBM’s Stock May Rise 7% Short Term.)

IBM Leads the S&P 500

Source: Yahoo! Finance, as of Thursday, Oct. 4, 2018

While the revenue decline in recent years may seem to warrant the current negative outlook on IBM, a closer look reveals that the $28 billion drop in revenue over the past six years is largely due to currency fluctuations and divestitures, as opposed to mere secular declines in the company’s business. Excluding those factors, the revenue decline amounts to about 1% a year, compounded. Revenue is expected to grow by 1.5% this year, and Roy predicts IBM to exhibit sustained revenue growth, albeit nothing spectacular, through 2022.

Much of the strength in revenue growth will come from IBM’s cloud presence. Despite larger competitors like Amazon.com and Microsoft, IBM’s cloud business is large enough to support its analytics businesses, including machine learning. (To read more, see: UBS: Buy IBM on Cloud Growth Opportunities.)

Looking Ahead

Roy’s contrarian perspective depends on IBM’s ability to compete in the cloud business as well as strengthening revenue growth. As IBM has been a disappointment to investors for years, it may take a few quarters of positive growth to convince investors that it has really turned things around. If that happens, its currently undervalued stock could be a bargain with potential for long-term gains.