IBM vs Microsoft Stock: Which Is Best?

International Business Machines Corporation (IBM) [NYSE: IBM] is an American multinational technology and consulting company that provides hardware, software, cloud, hosting and consulting services along with cognitive computing. It is one the world’s most iconic technology behemoths as well as one of the most valuable global brands. IBM is also one of the world’s largest technology and consulting employer with more than 352,000 employees serving clients in 170 countries.

IBM is over 100 years old and the technology company is known for continuous innovation ever since its inception as Computing-Tabulating-Recording Company in New York State by Charles Ranlett Flint in 1911, following the merger of four companies. The Armonk, New York-based company, which has helped pioneer multiple segments of the computer industry, changed its name to IBM in 1924.

The company operates through Cloud and Cognitive Software, Global Business Services (GBS), Global Technology Services and Global Financing segments. 

IBM is also a major research organization and, as of 2020, holds the record for maximum number of U.S. patents received for the 20th consecutive year. IBM, sometimes referred to as ‘Big Blue’, is renowned for major inventions such as the floppy disk, the hard disk drive, the SQL programming language, the UPC barcode, and dynamic random-access memory (DRAM) to name a few. IBM, with more than 3,000 researchers in 12 labs located across six continents, is now transitioning from being an infrastructure player to one that is more cloud and data driven.

What does Microsoft do?

Microsoft Corporation [NASDAQ: MSFT] is an American multinational technology company, which develops, manufactures, licenses, sells, and supports computer software, hardware and solutions worldwide. Microsoft also develops video game consoles and digital music entertainment devices. Together with Facebook (FB), Amazon (AMZN), Apple (AAPL), and Google (GOOG), it considered one of the Big Five technology companies or “FAAMG”. 

Microsoft is best known for its Microsoft Windows line of operating systems, which dominate the PC landscape, powering over 90% of the world’s desktop computers and laptops. Its Microsoft Office software, encompassing a suite of e-mail, word-processing, spreadsheet and presentation tools, dominates 90% of the market and is a major revenue generator for the company.  The company has expanded over the years into productivity software, server software, internet services and video games.

Its other well-known products include video chat and voice calls telecommunications application Skype (purchased for $8.5 billion in 2011), employment-oriented online service LinkedIn (purchased for $26.2 billion in December 2016), cloud platform Azure, code collaboration platform GitHub, software development platform Visual Studio, search engine Bing and Edge web browser. Its hardware products are the Xbox video game consoles and the Microsoft Surface lineup of touchscreen personal computers along with different PC hardware and accessories. The Redmond, Washington-based company founded by Bill Gates and Paul Allen on April 4, 1975 went public in 1986, creating a few billionaires and thousands of millionaires among Microsoft employees

Is IBM Stock A Good Buy?

There is absolutely no doubt about the fact that IBM is one of the most iconic companies in the US, but, then, there is also no denying the reality of IBM’s stunted performance over the years. Big Blue, in fact, has struggled for quite some time now and the same is reflected in the company’s revenue growth, valuation and stock performance, with IBM stock down about 16% over the past five years.

The iconic technology company, which was more of a computer technology trendsetter for decades, has floundered over the years. The growth of the internet and the challenge posed by some of the new tech companies that came into existence in the 1980s seemed to have caught the illustrious company off guard. IBM initially lacked the foresightedness to anticipate the direction technology and computer architecture would be taking with shifting consumer preference for distributed computing.

However, the company is now currently undergoing a long and massive restructuring process, having decided to split into two companies by spinning off its slower-growth IT services business. The split, likely to occur by the end of 2021, and then putting a new chief executive at the helm, IBM has made its desire clear to bring back its old days of glory.

IBM updated investors on its third-quarter earnings report in October. The top-and bottom-line results were roughly in-line with the technology company reporting $2.58 earnings per share (EPS) for the quarter, meeting the consensus estimate. IBM earned revenues of $17.60 billion for the quarter, slightly ahead of the estimates of $17.56 billion. The Global Technology Services segment, IBM’s largest, generated $6.46 billion in revenue. Cloud and Cognitive Software, which includes Red Hat, delivered $5.55 billion in revenue, which is up 7%, whereas revenue from Global Business Services fell 5% to $3.97 billion.

Revenue from Global Business Services totaled $3.97 billion, while Systems revenue fell 15% to 1.26 billion. The company blamed the coronavirus pandemic for its lackluster performance, in part, because of exposure to industries such as retail and transportation that suffered because of the contagion. IBM also pulled its forward guidance.

A variety of factors could be attributed to Big Blue’s more than a decade of underperformance. The company suffered from a leadership gap as the stock price declined over 20% during former CEO Ginni Rometty’s eight years’ tenure. The company finally decided to hand over the reins this year in April to Arvind Krishna, who was previously senior vice president for the Cloud and Cognitive Software business.

Second, the firm’s multibillion-dollar investment in Watson proved to be a damp squib with the technology failing to find acceptance in the sectors IBM initially projected.

Watson, named after IBM’s founder and first CEO, Thomas J. Watson, is a question-answering supercomputer, which combines artificial intelligence (AI) and sophisticated analytical software to answer questions posed in natural language.

More importantly, IBM was a foot-dragger when it came to the adoption of the highly lucrative cloud business, now principally dominated by Microsoft Azure and Amazon AWS.

Fourth, the company has been grappling with continuously sliding revenue. In fact, revenue declined 2.5%, falling for the third consecutive quarter on an annualized basis, a redux playing out under new CEO Arvind Krishna, who could be forgiven for thinking history was on a doom loop, as his predecessor Ginni Rometty had to deal with the same situation. Overall, the company generated around $77 billion in revenue in 2019, whereas it had generated more than $110 billion in 2011.

On October 8, IBM finally decided to take the bull by its horns. The company began a dramatic multi-year restructuring with vigorous focus on cloud computing. The company changed its CEO earlier this year which immediately caused the share to jump by more than 5%.

Leaders with experience and foresightedness can do wonders, as shown by Indian-American business executive Satya Nadella who replaced billionaire Steve Ballmer as Microsoft CEO in 2014.  He steered the company away from a failing mobile strategy and placed greater emphasis on segments such as cloud computing and augmented reality.

In fact, he oversaw in 2016 the acquisition of professional network LinkedIn for $26.2 billion. Nadella has been widely credited for putting lagging technology giant Microsoft back on top, with the company’s stock skyrocketing more than 150% since he took command of the Windows OS developer.  Similarly, investors are optimistic that Krishna, who has many years of experience in cloud computing, will make IBM a bigger player in an industry that has allowed other companies mint billions in revenue and profit.

While there are challenges galore, there are a still a few good reasons it should be on your investment radar.

Spinning-off managed infrastructure services unit to focus more aggressively on cloud

IBM recently announced its plan to spin off its $19 billion Managed Infrastructure Services (MIS) business, which is part of the Global Technology Services (GTS) division, into a publicly traded company to better focus its efforts on cloud computing and artificial intelligence.

The spun-off unit, which will be a tax-free deal, will focus on managing and modernizing client=owned infrastructures. IBM expects the deal to be completed by the end of 2021.

The new entity plans to focus on designing, operating, maintaining and modernizing client-owned infrastructures, a $500 billion market opportunity. The company will offer its expertise in hosting and network services, infrastructure modernization, and migrating and managing multi-cloud environments. The company is focused on developing and expanding an open hybrid cloud platform. “IBM is laser-focused on the $1 trillion hybrid cloud opportunity,” Chief Executive Arvind Krishna said in written remarks with the restructuring announcement.

A hybrid cloud architecture will equip IBM with the capability of offering its clients both, a public cloud and a private cloud service. IBM’s $34 billion deal to acquire Red Hat had a strong link with its hybrid cloud aspirations as Red Hat provides an open source, cloud software business, a critical component of IBM’s intense desire to offer a hybrid cloud architecture to its customers.

In the past one year, IBM’s cloud business generated a revenue of $23.5 billion, up 20% from the previous time span.  Today, cloud contributes around 30% of IBM’s total revenue whereas it contributed only 4% of its revenue in 2013.

A solid dividend payer

Also, IBM is a well-known dividend aristocrat, having continuously increased its dividend payouts for more than 25 years and returning $97 billion to shareholders in the last eight years. The firm has a dividend yield of more than 5 percent, which is great in a low-yield environment.

Low valuation

Another thing working in IBM’s favor is its low valuation. The company’s trailing and forward PE ratios are below the S&P 500 average and that of its peers.  Investors, happy at the prospect of grabbing the share at a low price, should also ensure that they do not become a victim of a value trap. A win-win scenario is a stock with low valuation, but possessing the ability of multiple expansion in that valuation.

To sum it up, IBM is a company in transition, which makes it a wait-and-see opportunity.  A new CEO, massive investment in scaling its cloud operations and artificial intelligence offerings and emphasis on revenue growth bodes well for the company. And, if you are still skeptical, you can dive in to collect a 5% yield while waiting for a clear picture to emerge.

Should you invest in Microsoft?

A couple of decades ago, Microsoft was at the top of its game, when it was called the most valuable company in the world. Today, the maker of Windows operating system no longer occupies the top place, but it would be a grave folly to write it off, even as other tech titans like Alphabet [GOOG, GOOGL], Apple [AAPL] and Facebook [FB] continue to shatter records in the stock market.

The software giant, under its CEO Satya Nadella, has won tremendous praise for its timely and highly fruitful transition from desktop computing to cloud computing. The company’s cloud offerings today include public cloud computing platform Azure (formerly known as Windows Azure), Office 365 productivity software, Enterprise Mobility Suite, Microsoft Visual Studio and Microsoft SQL server, to name a few.

Microsoft over the years

Early PCs made by IBM and Apple ran on Microsoft’s software. The real boom for the company, though, came when technological advances caused the PCs to become smaller as well as cheaper. As a result, PCs were no longer confined to corporations and academia, making it possible for common folks to own a PC. The PC market began to expand at an exponential rate, catapulting Microsoft to an astral plane as the company charged a licensing fee on each computer sold with Windows and Office.   

Cut to the present, and we see that the importance of Windows OS has not diminished as it is still the major cash cow for the tech titan. However, this has not stopped the software maker to venture out into other highly promising growth prospects such as cloud computing, video games and social network to name a few.

Microsoft was founded in 1975, and, since then, the company has had three CEOs. First was co-founder Bill Gates, whose tenure marked the golden era for the company as it experienced unprecedented growth and made Bill Gates the richest person on earth. He was followed by Steve Balmer, whose tenure was a constant struggle as the company failed to leverage its expertise and dominant position to dominate high growth segments such as search engines and social networks. Microsoft seems to have found its mojo once again under current CEO Satya Nadella as the company returns to prominence with a stellar stock market performance, revenue diversification and most important of them all—cloud computing. 

Today, one of Microsoft’s biggest “pros” is fundamentally identical to what it was a couple of decades ago. The company’s Windows operating system enjoys a very high barrier to entry as the familiarity with the OS means it is the preferred choice for users around the world, which, in turn, means its dominance over the PC landscape remains unchallenged.

Windows is part of a business segment Microsoft labels “More Personal Computing,” which also includes the Xbox and associated services, sales of the Surface tablet and search engine Bing. Apart from Bing, which continues to lag behind search engine giant Google, More Personal Computing contained a few silver linings in the latest quarter.  The sale of its Surface (something between tablet and a laptop) devices surged, resulting in 37% increase in revenue as the Covid-19 pandemic encouraged work-from-home and learn-at-home trends.

Good performance by Windows and a solid show put in by Surface devices drove revenue in the More Personal Computing segment up 6% year over year.

However, the major revenue driver at this point for Microsoft is the cloud. The company does this in two ways: first, it offers its suite of Office 365 productivity software as a cloud-based “software as a service” (SaaS) offering. Instead of earning a one-time fee when someone buys Microsoft Office, the company now charges an annual fee of $99.99 and allow the buyers to use Office across all devices.

The second way Microsoft is tremendously benefitting from the cloud is with its cloud computing offering, Azure, whose revenue soared by 48% year over year in the fiscal 2021 first quarter. Microsoft Azure is now the second largest player in this rapidly growing segment, just behind Amazon Web Services. Other major players in the cloud computing segment include Alphabet (GOOGL) unit Google Cloud Platform, along with Chinese heavyweights Alibaba (BABA) and Tencent (TCEHY).

The growth story is likely to continue as Azure wins lucrative federal contracts even as it forges new partnerships with private corporations. In October 2019, Microsoft edged out favorite AWS to win a $10 billion cloud-computing contract with the U.S. Department of Defense. The contract, known as JEDI, or Joint Enterprise Defense Infrastructure, spread over a 10-year period was awarded to Microsoft despite allegations from Amazon that President Trump’s bias against the e-commerce giant influenced Pentagon’s decision to award the contract to Microsoft.

Also, SpaceX’s Starlink project, a satellite network that the private spaceflight company SpaceX is developing to bring low-cost satellite internet to all areas of the world, is using Azure as its cloud partner.

Microsoft’s final segment, Productivity and Business Processes, which include Microsoft Office and LinkedIn, also delivered solid performance in the first quarter of fiscal 2021, and in conjunction with other segments pushed Microsoft’s revenue up 12% year over year. The tech giant earned $1.82 a share, up 32% from the same period a year before, on sales of $37.15 billion. Analysts expected EPS of $1.54 on sales of $35.72 billion.

For the December quarter, Microsoft expects to generate sales of $39.95 billion, a tad below expectations of $40.4 billion. Sales in the year-earlier quarter were $36.91 billion.

The risk associated with long-term investment in Microsoft is not much to worry about given the fact that Microsoft’s name, unlike its Big Tech peers Facebook, Alphabet and Amazon, is absent from the U.S. government’s list of companies it intends to subject to antitrust investigations. More interestingly, Microsoft is the darling of major credit rating agencies, all of which hold the unanimous opinion that MSFT is less likely to default on its obligations than Uncle Sam itself. It may sound incredible, but Microsoft, along with Johnson & Johnson [JNJ], is more likely to pay back your loan than the federal government. As an investor, you would be hard-pressed to find such a financially stable company.

Microsoft Stock Vs IBM: The Bottom Line

Risk versus reward:  Microsoft is a remarkable stock to own

Microsoft stock was down 4% in October, as the company’s revenue guidance was lower than analysts’ estimates. This, however, makes it easier for investors to own stocks of a company that is poised for more growth in coming years. This business is versatile and, during the coronavirus pandemic, it has amply proved its capabilities to adopt quickly to changing situations and circumstances. The tech company’s products and services are designed to work well with the changing needs of businesses and individuals as the pandemic forces people to stay indoors.

On the flip side, Microsoft’s price-earnings ratio (PE) and price-earnings to growth ratio (PEG) are on the higher side which makes the stock a bit expensive to buy. This per se is not unexpected as most growth stocks trade for higher multiples than the average market. The situation in case of Microsoft is a bit different though, as you cannot expect a trillion-dollar company to grow at a rate to justify such a high PE ratio. For example, back in the ’80s and ’90s, it wasn’t uncommon for earnings to jump more than 100% every two years or so. It won’t take much doing to increase revenue from $100 million to $200 million, but then turning $1 trillion to $2 trillion is altogether a different ball game.

Additionally, when it comes to a stock of a big technology company such as Microsoft, there’s always the risk of a competitor developing a breakthrough product in emerging areas such as AI, deep learning or quantum computing, which could cause the Washington-based company to lose share. However, experts believe that the probability of such an occurrence is remote as tech savvy Satya Nadella is unlikely to miss these massive paradigm shifts in technology where Microsoft aggressively competes.

Also, Microsoft is not without muscular challengers in nearly every industry in which it has an interest. Laptop/tablet hybrid Surface is one of its fastest-growing segments, but it would be incredibly difficult for it to surpass sales of the iPad anytime soon. Likewise, no one expects Bing to overtake Google in the foreseeable future. Microsoft’s cloud business, Azure, is a shing star clocking sales growth of 48% in the latest quarter. However, AWS still remains the market leader. New competitors like Slack (WORK) and Zoom (ZM) are snapping at the heels of Microsoft Teams, while new Xbox Series X gaming console’s (scheduled to be released on November 10) desire for dominance is going to face stiff challenge from new PlayStation 5 this holiday season.

The company acquired video game studio ZeniMax Media (owner of some of the industry’s leading game studios) in September for $7.5 billion in cash as it sets its eyes on capturing a larger share of the global gaming market, expected to generate more than $200 billion in revenue by 2021.

The great news is that Microsoft is still growing at a good pace, and this is most likely to continue in the years to come as it evolves and develops new products. Having said that, it should not be forgotten that the Windows and the Office suite of products still hold the key to MSFT’s incredible success. They brought in sacks full of dollars for the company in the 1990s, and they continue to do so in the 2020s. Microsoft remains dominant in these markets, and that, together with its continued ability to innovate and uncover new growth opportunities, make it a viable company with a bright future ahead.

Last, but certainly not the least, investors should not forget that MSFT is a very low-risk investment. If you set aside the normal volatility associated with equity investment, you will find it incredibly tough to pick any real threat that could remotely pose a challenge to its bread-and-butter cash cow. Also, it does not have to contend with the threat of extreme legal or antitrust action from the government. 

The fact that its financial security is thought of as safer than the government’s bonds is nonpareil. It pays a dividend of 1.05%, slightly higher than the 0.8% offered by the 10-year Treasury right now. Investment as such in Microsoft is better than the 10-year Treasury as, apart from a better dividend, you are likely to benefit from sizeable capital gains.

IBM: Turnaround Is Underway

IBM, today, is laser-focused on expanding its presence in the hybrid cloud and AI markets. Hybrid cloud platform combines a private cloud with one or more public cloud platforms with proprietary software enabling communication between the two. This type of arrangement is best suited for organizations who wish to enjoy the additional levels of flexibility and scalability of public cloud along with the added security provided by private cloud. Its subsidiary Red Hat, which it acquired last July for $34 billion, provides open-source software to manage communication between the two platforms.

According to the company, “IBM’s open hybrid cloud platform architecture, based on RedHat OpenShift, works with the entire range of clients’ existing IT infrastructures, regardless of vendor. This platform allows clients to “write-once/run-anywhere,” and enables a hybrid cloud approach that drives up to 2.5 times more value for clients than a public cloud-only solution.

IBM recently announced its plan to spin off its infrastructure unit in a tax-free deal. IBM, after shedding its excessive baggage, will be in a better position to go after what it sees as a $1 trillion opportunity in hybrid cloud computing. While the company has a small market share, it estimates it will soon be worth billions of dollars as its big-name clients and government companies move into the cloud.

There are few downsides to IBM, too. IBM is a company in transition, with the tech giant embarking on a path of transforming itself from a legacy IT provider to a cloud computing giant. Investors as such will be concerned about how things shape up few years down the line. Analysts expect the revenue to decline 4% this year before it modestly rebounds by 1.6% next year. Earnings are expected to fall 13% this year and rebound just 10% next year. It is abundantly clear that 2020 is not going to be a great year, nor is the next quarter going to bring any blockbuster changes. However, the future holds a lot of promises as it expects bulk of its revenues coming from higher-value software and solutions, with more than 50% of its total revenue being recurring in nature.

IBM is not a name you would generally associate with robust growth — just the opposite, actually with the stock proving to be a laggard over the past 7 years. The company’s turnaround has been a glacially slow process, and growth has not been much to write home about. As such, investors overlooking it for other high performing tech companies should hold no surprises for anyone. 

However, IBM is priced low and enjoys a solid reputation for consistent dividend with the company paying quarterly dividends for over 100 years.  If we can get to the point where the iconic technology behemoth can change the narrative, and a hybrid cloud-focused IBM grows at a consistent pace, bargain hunting investors buying the stock today can expect to reap rich rewards in the future. 

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.