IBM (NYSE: IBM) has tested the patience of many investors over the past five years, as its stock has fallen nearly 20% against the S&P 500's near-75% gain. Even Warren Buffett, the paragon of long-term investing, dumped all of Berkshire Hathaway's IBM shares earlier this year.
But are investors giving up on Big Blue too soon? After all, it finally broke a 22-quarter streak of year-over-year revenue declines with two quarters of growth this year. Analysts expect IBM's revenue and earnings to grow just 1% this year, but that anemic growth indicates that the stock -- which trades at just 11 times forward earnings -- could be bottoming out. IBM also pays a forward yield of 4.1% to investors who are willing to stick around.
Image source: Getty Images.
Let's take a look at how IBM has changed over the past five years and where the company could be five years from now.
Revisiting IBM's past mistakes
Back in 2010, IBM's then-CEO, Sam Palmisano, promised to double the company's annual EPS from $10.01 in fiscal 2009 to $20 by 2015. Unfortunately, Palmisano's "Roadmap 2015" plan mainly consisted of selling business units, cutting costs, and repurchasing lots of shares. That strategy boosted IBM's EPS, but it fell behind the tech curve as companies like Amazon (NASDAQ: AMZN), Microsoft (NASDAQ: MSFT), and Alphabet's (NASDAQ: GOOG) (NASDAQ: GOOGL) Google expanded their cloud ecosystems.
As a result, IBM's top-line growth stalled out. Ginni Rometty, who replaced Palmisano in 2012, initially continued to follow Roadmap 2015 but abandoned the $20 promise in late 2014.
Revisiting Rometty's 10-year plan
That same year, Rometty introduced a new 10-year plan for IBM, which prioritized its growth in the cloud and other next-gen markets over raw EPS growth. The centerpiece of that effort was cloud services provider SoftLayer, which IBM acquired in 2013.
Rometty's primary goal was to continue reducing the weight of IBM's legacy hardware, software, and IT services businesses while increasing its investments in five "strategic imperatives" -- the cloud, analytics, security, mobile, and social markets. At the time, Rometty told The New York Times: "We are transforming this company for the next decade, that is not a one-year job. Not when you're a hundred-billion-dollar company."
Under Rometty's guidance, IBM expanded the IBM Cloud platform with new services to compete against Amazon's AWS (Amazon Web Services) and Microsoft's Azure, expanded its AI platform, Watson, in a stand-alone business unit, rolled out an industry-leading enterprise blockchain service, and increased its investments in next-gen industries like quantum computing.
Here's how IBM's strategic imperatives (SI) revenues has performed over the past four years.
% of IBM's revenue
Data source: IBM quarterly reports.
During the second quarter of 2018, IBM reported that its SI revenues rose 15% annually over the past 12 months to $39 billion and accounted for 48% of its total revenues. These numbers all strongly indicate that Rometty's turnaround plans are paying off.
The bulls vs. the bears
IBM is now roughly at the halfway point of Rometty's 10-year plan, and the bulls believe that the company's ongoing investments in its SI segments, along with the growth of certain higher-growth hardware businesses (including IBM Z, Power Systems, and storage products), will help it generate consistent sales and earnings growth again.
However, the bears claim that IBM faces too much competition in the higher-growth cloud space and that its stock isn't cheap relative to its earnings growth potential. They certainly have a point, since IBM still ranks a distant fifth in the global cloud services market, according to Synergy Research. The market is currently led by AWS, Microsoft Azure, Google Cloud, and Alibaba (NYSE: BABA) Cloud -- in that order.
Image source: Getty Images.
Amazon, Microsoft, Google, and Alibaba are also adding next-gen services like blockchain and AI to their cloud services, which could force IBM to spend more cash while cutting prices to stay competitive.
Analysts currently expect IBM's earnings to grow at an average rate of just 1% over the next five years. This gives its stock a whopping five-year PEG ratio of 12. A PEG ratio of less than 1 indicates a stock is undervalued relative to its growth, so IBM's stock doesn't look cheap relative to those longer-term forecasts. Microsoft, Amazon, and Alphabet all have PEG ratios that are closer to 2.
A work in progress
IBM remains a work in progress, but it's definitely faring better under Rometty's leadership. I think IBM will continue to grow its SI revenues with new services and acquisitions and that it will slowly but steadily become a stable investment over the next five years.
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