Global technology giant IBM (NYSE:IBM) performed great during the first three quarters of 2019. From January to September, IBM stock rattled off a 30% gain as investors became enthusiastic about the company’s acquisition of Red Hat. They thought the deal would usher in a new era of sustainable growth by IBM.
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But since September, that enthusiasm has fizzled, mostly because of subpar third-quarter results. The Q3 numbers implied that, even with Red Hat, IBM will have a tough time driving sustainable revenue growth. Since late September, IBM stock price has dropped almost 10%.
The good news for IBM bulls is that this recent under-performance leaves IBM stock well-positioned to rally in 2020.
The market appears to be overreacting to mixed third-quarter numbers that had a lot of acquisition and business divestiture items in them. Excluding those items, which do not reflect the company’s core performance, the numbers weren’t bad.
The growth outlook of the company’s core cloud business is gaining momentum. IBM’s cloud business will continue to gain momentum in 2020, thanks to Red Hat. As a result, IBM’s revenue growth rates will move back into positive territory, and its margins will start to climb. This pivot back into growth mode will push IBM stock price higher.
My numbers suggest that IBM stock price can reach $150 in 2020. So while International Business Machines stock isn’t poised to climb a great deal, it can rise enough to make the shares interesting at $130.
IBM’s Growth Outlook Will Improve
The core of the bull thesis on IBM stock heading into 2020 centers around the idea that the company’s growth outlook will meaningfully improve as it leverages its Red Hat acquisition to become a bigger player in the hybrid multi-cloud market.
IBM’s growth trajectory has been flat for several years. The company’s legacy businesses are dying. While its new cloud businesses are growing, they haven’t been growing enough to offset the declines of its legacy business. Its revenues have consequently been falling, while its margins have been under pressure. As a result, its profits have not grown, preventing International Business Machines stock from rising.
In 2020, that should all change.
The cloud world is becoming increasingly complex, with more and more corporations employing a mix of on-premise, private, and public cloud environments. Most of these hybrid, multi-cloud environments are built on open-source operating systems. Linux is the most popular open-source operating system in the world, and Red Hat is the largest Linux operating system vendor. As a result, as the cloud world pivots towards hybrid, multi-cloud environments built on Linux, more and more companies will build their cloud systems with Red Hat’s offerings.
IBM recently closed its acquisition of Red Hat. Thus, Red Hat revenues are just now showing up on IBM’s financial statements. In 2020, they will show up more emphatically. As they do, IBM’s cloud business will gain enough momentum to offset its legacy business declines, its revenue will resume growing, and its margins will improve.
All of these positive developments should give beaten up IBM stock a sizable lift in 2020.
$150 Looks Doable in 2020
My estimates suggest that International Business Machines stock can exceed $150 within the next twelve months.
Here’s the math. IBM’s revenue growth rates, excluding currency fluctuations, are just below 0% today. Over the next few years, as Red Hat becomes a more meaningful revenue contributor and as multi-cloud environments become the norm, IBM’s revenue should climb around 2%-3%. On top of that, its pre-tax profit margins should increase as demand for its offerings rise, while its share buybacks should remain steady As a result, IBM’s earnings per share should rise at a 4%-5% annual clip.
Consequently, IBM’s earnings per share could hit about $16 by fiscal 2025. Based on an FY25 multiple of 12 times forward earnings (which is where the stock was trading earlier this decade when IBM’s profits were growing) and a 6% annual discount rate (10%, less the stock’s 4%-5% dividend yield), that equates to a 2020 price target for IBM stock of over $150.
The Bottom Line on IBM Stock
IBM stock price can’t climb tremendously. But it does have enough potential to make the shares interesting at their current price of $136 heading into what could be a strong 2020 for the company. As a result, while I’m not rushing out to buy IBM stock, I do think that a prolonged downturn of IBM stock price could turn into a buying opportunity.
As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.
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