IBM Stock Falls Post Strong Earnings. Should You Buy?

IBM stock (NYSE:IBM) posted a better than expected set of Q2 2022 results, with revenue rising by 9% year-over-year to $15.5 billion and adjusted earnings per share coming in at $2.31, up by over 40% versus last year, despite seeing headwinds from a strengthening dollar. While the spin-off of the low-margin information-technology services business has had a positive impact on IBM’s performance, the company is also benefiting from the strong demand in its consulting and infrastructure businesses. Consulting sales rose by almost 10% year-over-year to $4.8 billion, driven by technology consulting and hybrid cloud-related services, while infrastructure sales jumped 19% versus last year, led by the launch of the new z-16 generation of mainframes earlier in the quarter. Revenues from new mainframes are typically higher earlier in the cycle as customers upgrade quickly, although the company expects that sales will cool down a bit over Q3.

Looking ahead, IBM has reiterated its revenue growth forecast for the year, targeting mid-single-digit growth, despite concerns of a U.S. recession in the near term, as it expects demand for technology to hold up better than the broader economy. However, the company revised its free cash flow guidance to $10 billion, compared to a previous range of between $10 billion to $10.5 billion, due to cost pressures and currency headwinds. For instance, gross margins for the consulting business contracted by 340 basis points versus last year in Q2, due to a tight labor market. Moreover, IBM derives about half its revenues from outside the U.S. and the strong dollar (the U.S. dollar index is up about 10% this year) is also weighing on IBM’s results and outlook.

Although IBM stock declined by almost 4% in after-hours trading, following the publication of results, we think the stock is somewhat undervalued at current levels. At the current market price of about $138 per share, IBM trades at just about 14x consensus 2022 earnings and just about 13x projected 2023 earnings. This makes the stock a reasonably good value pick in a market where investors are increasingly prioritizing earnings and cash flows. Moreover, IBM could also hold up reasonably well in the event of an economic downturn in the United States. We value IBM stock at about $159 per share, roughly 15% ahead of the current market price. See our analysis  IBM Valuation: Expensive or Cheap for more details on what’s driving our price estimate for IBM. Also, check out the analysis of IBM Revenue for more details on how IBM revenues are trending.

While IBM stock has fared better than the broader market rising by about 3% year-to-date, the economic outlook looks increasingly uncertain, with the Fed raising rates amid surging inflation. See how low can IBM stock go by comparing its decline in previous market crashes. Here is a performance summary of all stocks in previous market crashes.

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[1] Month-to-date and year-to-date as of 7/19/2022
[2] Cumulative total returns since the end of 2016

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