With its second-quarter fiscal 2018 earnings report rapidly approaching, investors openly wonder about IBM (NYSE:IBM). Will the iconic but chronic underperformer finally live up to its potential, or will it be more of the same? Every year, an analyst tries his or her hand at IBM stock, and except for 2016, the ride has been nothing short of frustrating.
To provide some context, IBM stock is down a little over 4% year-to-date. Initially, that doesn’t sound too terrible considering that, at time of writing, a majority of Dow 30 companies are in the red. However, IBM is the only non-defense centric technology firm that is losing shareholders money.
The other tech names in the Dow – Apple (NASDAQ:AAPL), Intel (NASDAQ:INTC), and Microsoft (NASDAQ:MSFT) – are outperformers. All three shares are up at least 12% YTD. And I’m going to give defense contractor United Technologies (NYSE:UTX) a break.
The surreal meeting between President Trump and North Korea’s Kim Jong-un understandably, but myopically sunk military contractors.
Moreover, in the past five years, IBM is down almost 26%. In fact, you must go back to 2010 to see the last time shares extensively stayed at the price point where IBM is now. Put another way, buying and holding “Big Blue” hasn’t been profitable for roughly the last eight years.
The issue isn’t that the company is an underperformer. As its last Q1 earnings report demonstrated, IBM put up solid figures, even when discounting one-off tax benefits. For prospective buyers, the problem is time. Management has used an inordinate amount of the universe’s most precious resource, with very little to show for it.
And its 4.34% dividend yield doesn’t mean much if IBM stock will shed more than that in the markets.
IBM Stock Has Upside Potential
Given all the disappointments associated with IBM, do investors have any realistic scenario for profitability? Preferably one that doesn’t involve waiting another eight years?
I believe IBM stock can surprise people, and I mean that in a good way. For starters, this is the ideal juncture to consider going contrarian. Covering analysts have zero clue what to do with IBM. Out of 25 analysts, 15, or 60%, have issued a “hold” recommendation. Only seven are bullish, while three rate the shares as “underperform.”
Logic and experience tells me that if the majority had “buy” ratings, the low-hanging fruit would be gone by now.
But the most significant factor that can eventually drive IBM stock is the company’s strategic shift towards relevancy. While IBM still maintains its legacy businesses, the priority is clearly its “Strategic Imperatives” division. This includes what I call the sexy stuff: cloud computing, data analytics, artificial intelligence, cybersecurity, yes, even the blockchain.
I’m not just spouting the corporate line. IBM is dead-serious about the transition, and while it’s admittedly taking it’s sweet time, the results are tangible.
Last week, the company disclosed that Big Blue secured a $740 million deal with the Australian government. The contract is a techie’s dream, encompassing hardware and cloud-computing services, along with AI, quantum computing, and the blockchain.
Australia chose IBM to shore up its governmental capacities as it relates to tech-related services. Of course, it’s a major victory for the company as it’s Australia’s highest-valued contract of its kind. But it’s also telling that the government didn’t elect Microsoft, Intel, or another competitor. Management communicated value to their newest client, which bodes well for IBM.
Naturally, actualizing the bullish argument requires patience. But unlike prior years, IBM has generated meaningful, trustworthy momentum.
Don’t Give up so Close to Paydirt
It’s tempting to believe that the underperformance in IBM stock will continue indefinitely. The company is trying everything to stay in the game, yet the share price keeps stagnating. While not taking anything away from the frustrations, IBM could be right on the doorstep to something great. Now isn’t the time to step away.
Nomura/Instinet analyst Jeffrey Kvaal is the latest bull on IBM, initiating a “buy” rating. His reasoning? “Its Strategic Imperatives revenue grouping is nearing 50% of sales and growing 10%, led by cloud, analytics, and security. This should easily offset upper-single-digit declines in legacy businesses.”
IBM’s transformation isn’t lip service. They intend to dominate the digital ecosystem for the 21st century like they did for hardware in the last century. Eventually, Strategic Imperatives will be half of all sales, and then later, represent the majority. The company closing the deal with the Australian government is a lone, but significant example of its revamped vision.
As of this writing, Josh Enomoto did not hold a position in any of the aforementioned securities.
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