International Business Machines Corp. Stock Is All out of Downside, Which Is Intriguing

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The challenges surrounding International Business Machines Corp. (NYSE:IBM) are well-known at this point. IBM news isn’t great: most notably, revenue has declined year-over-year for 23 consecutive quarters. The IBM stock price hit a 52-week low in August; even after a recent rebound, the stock still is down about 30% from 2013 highs.

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But with IBM stock pulling back despite a strong Q3 earnings report, it’s starting to look tempting. The company’s “strategic imperative” revenue is growing and moving toward half of total sales. IBM stock is cheap, trading at under 11x 2017 adjusted EPS guidance. And a nearly 4% dividend yield makes the stock potentially attractive to income investors.

There are concerns here, and IBM is a bit of an odd stock: a tech and even “cloud” play that trades like an old-line, low-growth industrial. It might be too risky for dividend seekers looking for safety, and too challenged for tech investors searching for growth. But as IBM stock “fills the gap” downward after a post-earnings pop, a 4% yield and a decent valuation make it interesting at least.

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IBM News Is Getting Better

It’s too early to assume the turnaround at IBM is on the way, but the company is making progress. Q3 revenue declined just 0.4% year-over-year, albeit with modest help from the weaker dollar. Strategic imperative revenue (basically, the company’s growing businesses like cloud, analytics, mobile, and security) totals over 44% of the trailing twelve-month total.

It’s been a slow grind. Again, IBM is on track for its sixth consecutive year of declining overall sales, but IBM is getting to the point where more of its business is growing than declining. That, in turn, positions the company for potentially ending that multi-year trend as soon as 2018. Street estimates project a 0.1% decline next year.

And there are pockets of real growth here. “As a service” revenue is at a $9.4 billion annual run rate, up 25% year-over-year. Cloud revenue over the past year has grown the same amount. Consulting and mainframes remain weak, but IBM is starting to execute in some of the more intriguing areas in tech. Overall, strategic imperative revenue grew 10% in Q3, up from 7% the quarter before.

It’s too early to see IBM as the next Microsoft Corporation (NASDAQ:MSFT) or Intel Corporation (NASDAQ:INTC): a one-time giant adapting to the quickly changing technology landscape. In cloud, for instance, IBM is behind, simply put. Both Microsoft’s Azure and Amazon.com, Inc. (NASDAQ:AMZN) Web Services are well ahead in terms of both revenue and technology.

But IBM is getting its act together. Analysts cheered the Q3 report and with good reason. The company by no means is out of the woods. But then again, IBM stock isn’t priced that way, either.

The IBM Stock Price Looks Cheap

IBM stock still is priced for a decline. The company guided 2017 adjusted EPS to $13.80 per share. With IBM having given back post of a 9% post-earnings pop, the stock is back under 11x EPS, and at a similar multiple to free cash flow.

Basically, the stock is pricing in continued modest weakness in line with recent results. And so the bull case for IBM stock is that investors are getting something close to a free option on further improvement. If IBM can post more quarters like Q3, EPS should start to grow as soon as next year, and IBM stock should gain. If, instead, operating earnings stay roughly flat, or even decline modestly, IBM stock shouldn’t have much more in the way of downside. And a 4% dividend yield offers both income and potentially some support for the stock.

To be sure, a dividend alone can’t support a struggling business, as investors in General Electric Company (NYSE:GE) know all too well at the moment. And there are concerns: Lawrence Meyers argued this week that a single earnings report doesn’t offset all those concerns.

And Meyers is right, but that doesn’t mean the report should be ignored or that the post-earnings gain in IBM stock should have evaporated. IBM news is getting better, there’s hope for overall growth on the horizon, and the stock is priced for close to zero improvement. It’s not a perfect bull case, but it’s intriguing enough for investors to take a long look at IBM stock.

As of this writing, Vince Martin has no positions in any securities mentioned.

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