International Business Machines Corp. (IBM, Financial), more commonly known as IBM, is one of the most historically important companies in the technology industry, but my analysis shows its high growth period could be over. With the advent of a new technological revolution driven largely by artificial intelligence and its associated automation, I believe the company is going to face significant threats from newer companies that will inhibit its growth.
As such, I believe investors are paying too high an opportunity cost by investing in the established giant and not considering smaller, high-growth companies that are new in the field and heavily invested in AI operations.
Operations analysis and updates
IBM has a rich history of technological innovation, but is facing the modern challenges of rapidly evolving technology demand. It continues to navigate a crucial pivot from a leading hardware provider to a leader in cloud computing and AI. I believe that while these efforts are commendable, the competition is fierce and, over time, the company will be known as a legacy provider. It is evident to me the company will continue to be important for some time, but its high growth period is now over. Instead, it is facing a new period of maintaining revenue and earnings alongside slower growth periods. As such, its high dividend will be more valuable to potential shareholders than ever.
Its AI initiatives are centered around its platform called Watsonx. It is designed to provide AI models to manage the entire lifecycle of AI for business, with full development and governance provided. Its core operational markets for the platform include code modernization, customer service and digital labor.
The company's hybrid cloud strategy is centered around its Red Hat OpenShift platform, which is designed to provide workflow integration of multiple private and public clouds seamlessly. IBM's strategy here is to change cloud architectures to be more design-focused, adding value to enterprises through ease of use. Virgin Money (CBBYF, Financial), Nokia (NOK, Financial) and the Boston Red Sox are some of the key partners leveraging its technology.
Adobe (ADBE, Financial), Amazon's (AMZN, Financial) AWS division, Microsoft (MSFT, Financial) and SAP (SAP, Financial) are also crucial partners for IBM, providing more than 40% of its consulting revenue. This is clear evidence to me of just how proficient the company remains in the new era of technology companies. With its initial public offering in 1949, its rich legacy leaves it with immense experience in operating effectively in technology over long periods of time.
Competition, market and financial analysis
Interestingly, some of the companies that IBM consults for are also those that are of the highest long-term threat to its business. For example, SAP's comprehensive suites in enterprise resource planning, customer relationship management and supply chain management directly compete with IBM's offerings. But it also faces significant competitive threats from Accenture (ACN, Financial), Oracle (ORCL, Financial) and Cognizant (CTSH, Financial). But I believe the technology markets are shifting so fast and so dramatically that its competitors are even more wide-ranging and perhaps considerably unpredictable, as new upstarts like ServiceNow (NOW, Financial) and Salesforce (CRM, Financial) begin to dominate its enterprise offerings, pushing IBM's utility in the area to the wayside.
For the purposes of this analysis and as a means to evaluate the opportunity cost of not investing in some of the newer and higher-growth enterprises, I have chosen a peer analysis that mixes older companies alongside newer ones. Consider the following breakdown of key financial data at the time of writing for my chosen peers:
| IBM | Oracle | Cognizant | Salesforce | ServiceNow | |
| Equity-to-Asset | 0.17 | 0.04 | 0.72 | 0.6 | 0.44 |
| Net Margin | 12.13% | 20.27% | 10.99% | 11.87% | 19.3% |
| 3Y EPS Growth Rate | 3.5% | 2.9% | 10% | 45.3% | 140.6% |
| 3Y Futue EPS CAGR Estimate | 4.76% | 28.64% | 5.19% | 16.66% | 21.11% |
| Forward PE Ratio | 18.91 | 19.95 | 16.01 | 31.02 | 57.36 |
| IPO | 1949 | 1986 | 1998 | 2004 | 2012 |
| Market Cap | $174.11B | $344.31B | $36.65B | $292.34B | $155.6B |
| Dividend Yield | 3.48% | 1.27% | 1.59% | 0.13% | 0% |
| 10Y Price Return | 4.89% | 216.58% | 48.16% | 440.59% | 1210.65% |
Based on these metrics, you will notice IBM appear to have a few advantages in comparison to its peers, but pales in growth reward when analyzed alongside ServiceNow and Salesforce. I believe investors should consider the opportunity cost they are paying if allocating to IBM instead of to playes like Oracle, Salesforce or ServiceNow. While I understand the premium valuation of the newer companies may be a deterrent, it is there for a reason. Further, while markets are not completely efficient, the general rule does apply.
Where IBM has significant appeal is in its higher dividend yield, which is the highest of all competitors in the analysis. But how much is this really worth when we consider the 10-year total price return of each of the five companies? IBM significantly underperforms by a wide margin. Further, consider that the S&P 500 has returned 182.04% over the last 10 years, revealing a recent history of general market underperformance for IBM as well.
Valuation
One area where IBM appear to do relatively well, based on my peer analysis, is its forward price-earnings ratio. However, upon closer inspection, I can see the opportunity is not as good as it seems. For instance, the GF Value Line, which takes into account historical multiples, the company's past returns and future estimates of business performance, indicates the stock is modestly overvalued currently.
What this chart shows me is that due to relatively poor future growth estimates, as also outlined in my table above, the current valuation could be considered too high. I agree with this, especially when we consider the company in a discounted earnings model, where my estimated earnings per share without nonrecurring items annual growth rate of roughly 5% over the next decade leads to a negative margin of safety of almost 60%. I have kept a normal 4% terminal stage annual growth rate, in line with typical annual U.S. inflation, and applied a 10% discount rate, which is my low-end annual expected portfolio return. Here is my result:
Other notable risks
IBM is shifting its focus away from consumer chip manufacturing and toward software and services, so its long-standing history of success in chips may begin to wane. While I understand the pivot may be deemed necessary, it is also prudent to consider how tough the market in AI, quantum computing and cloud technology is. Its past success in chips is not guaranteed to repeat in its new endeavors. And in fact, my prediction is it will have some significant defeats and challenges ahead. While the company is already leading in many domains, and its past results are important to the industry and must be respected, innovation is reliably disruptive to the balance of power, and with the advent of AI and automation, I expect history to repeat itself in pushing new companies into dominant positions in the industry.
Conclusion
Based on my analysis of IBM, I cannot see a reason to rate the stock a hold or a buy. So my conclusion is that it is a sell, by my standards. My core reason for this decision is that I see it as highly unlikely the company will outperform the broader S&P 500 Index over the next decade, and it certainly will not outperform some of the newer high-growth companies. As such, its dividend becomes one of the vital attractions, but even then, I am personally not compelled by a 3.50% yield when I could get 20%-plus capital gains elsewhere. IBM still has a lot to offer the technology industry, but as far as the stock goes, there are definitely better investments available.
