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Big technological change can lead to eye-popping investment returns, but it's not the only way to invest in tech. And because tech changes rapidly, it can make investing in the space intimidating for some. You can back incremental advancements to software, hardware, cloud computing infrastructure, etc. and still make plenty of money.
Two tech "blue chips" that offer stability and a diverse product lineup across all of these categories are 108-year-old International Business Machines (NYSE: IBM) and 21-year-old Alphabet (NASDAQ: GOOGL) (NASDAQ: GOOG). IBM is currently a full-service enterprise IT service provider across software, platforms, security, consulting, and even specialized hardware. Yet IBM has had a very difficult past decade or so. Some of its legacy businesses have been partially disrupted by the rise of cloud computing, though IBM has its own cloud offering as well.
Meanwhile, Alphabet has grown its Google search engine into the world's dominant search platform, with over 90% market share. It also has a burgeoning cloud computing offering, as well as a number of money-losing "Other Bets" in futuristic technologies such as self-driving cars that could pay off big in the future. And yet, Alphabet has also run into some issues lately, including slowing growth and regulatory scrutiny over its monopoly-like position in search.
So, which tech company is the better bet today?
Image source: Getty Images.
If you're looking for growth, then look no further -- the clear winner is Alphabet. Though growth has moderated a bit from its past trends above 20%, posting high-teens yearly growth at Alphabet's size is still an impressive feat:
Meanwhile, IBM has struggled to find its footing. Although last quarter IBM displayed growth in some key segments such as cloud infrastructure (up 12%) and consulting (up 9%), overall revenue was down (4.7%) due to currency headwinds, the decline in some legacy businesses, and declines in the mainframe businesses, which is "late" in its product cycle.
Both companies suffered from currency headwinds -- without the negative effects of currency, Alphabet's revenue growth would have been 19%, and IBM's revenue would have declined just 1%.
IBM is doing an admirable job of swimming upstream, but in terms of growth, it's no contest. Alphabet's digital advertising empire is still a steady growth engine and should be for the foreseeable future.
New growth seeds
Though each company has its own core offerings, both are reaching for new growth as well. Alphabet has several major initiatives, including its cloud computing offering and its Other Bets segments. It's hard to know exactly how the cloud division is doing, as Alphabet lumps the cloud in with its hardware and app store revenue in a category called "Google Other." That overall category grew at a rate of 25.1% last quarter, though it's likely Google's cloud grew at a higher rate, given industry trends.
Meanwhile, Alphabet's Other Bets across next-gen medicine, self-driving cars, internet connectivity, and AI research generated an operating loss of $868 million last quarter, meaning these new research activities continued to burn cash without regard for near-term profitability. Essentially, Alphabet is using its massive $100 billion-plus cash hoard to fund an internal venture-capital effort in the hopes of hitting it big.
IBM, on the other hand, announced a single large, transformational acquisition of Red Hat (NYSE: RHT) in October 2018 for a whopping $34 billion. The acquisition could benefit IBM in a number of ways. First, Red Hat is the largest service provider of open-source software, which helps large organizations manage their workloads across different tech platforms. This fits with IBM's focus on "hybrid cloud" solutions for customers that want to seamlessly manage workloads across the public and private clouds, as well as their own data centers, where IBM has had a traditional advantage.
IBM will also benefit from Red Hat's higher growth, which had been as high as 20% early last year, though it decelerated to 14% last quarter (though 17% in constant currency). Consistent growth is something IBM has been missing.
Finally, the acquisition should also allow for merger synergies and the cutting of duplicative corporate functions, which should also help IBM on the cost side.
While Google has growth, IBM is definitely the less expensive of the two stocks:
As you can see, Alphabet still retains its growth PE multiple in the 20s, while IBM still trades at a lowly 10 times forward earnings.
However, when considering each company's debt (or lack thereof), the valuation gap closes a fair amount, with each company's EV/EBITDA metrics closer to each other. That's because Alphabet is swimming in excess cash, while IBM has a substantial $50 billion in debt, though $30 billion of that is its financing division, meaning the company has an operational debt of only $20 billion. Nevertheless, that operational debt is set to double, as IBM just sold another $20 billion in bonds to fund its all-cash Red Hat acquisition.
That's why Alphabet's forward EV/EBITDA, which projects next year's figures, is only 11.5, while IBM's forward EV/EBITDA is a much closer 8.1.
What kind of investor are you?
For most investors, Google parent Alphabet appears the way to go. It's still generating healthy organic growth, has a huge balance sheet, a number of high-upside "lottery tickets," and a reasonable valuation. That makes it a safer play.
However, IBM's dirt-cheap valuation could give it a big boost if it actually succeeds in growing its cloud services, and if the Red Hat acquisition expands growth and profits. Meanwhile, shareholders are paid a dividend of more than 5% as they wait.
That could make IBM the choice for deep value investors; however, it's a much riskier play. Since Alphabet seems the higher-quality business at the moment and still has a reasonable valuation, it remains the better choice for most investors.
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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Billy Duberstein owns shares of Alphabet (C shares) and IBM. His clients may own shares of the companies mentioned. The Motley Fool owns shares of and recommends Alphabet (A shares) and Alphabet (C shares). The Motley Fool is short shares of IBM. The Motley Fool has a disclosure policy.