While It Looks Good Long Term, IBM Stock Has a Bumpy Ride Ahead

Dividend Stocks

On Oct. 16, International Business Machines (NYSE:IBM) stock reported disappointing Q3 revenue that missed estimates. It was the fifth consecutive quarter of decreasing sales figures from IBM stock.

While It Looks Good in the Long Term, IBM Stock Has a Bumpy Ride Ahead

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Despite the fall in IBM share price following the release of earnings, year-to-date, IBM is still up about 18%.

Although there is likely to be further choppiness in the shares, long-term income investors may want to keep a close eye on IBM stock as the current dividend yield stands at a lofty 4.8%. Let us now see how the rest of the year may develop for International Business Machines. Will Big Blue likely get over its revenue blues as it goes for growth in cloud services?

How IBM Makes Money

In recent years IBM has become a diversified company with a wide range of worldwide offerings, including IT hardware, software, and services. Five businesses generate revenue for IBM.

  • Cloud & Cognitive Software, which includes cloud and data platforms, cognitive applications and transaction-processing platforms.
  • Global Business Services, or GBS, which includes consulting, application management and global process services.
  • Global Technology Services, or GTS, which includes infrastructure and cloud services and technology support services.
  • Systems, which includes systems hardware and operating systems software.
  • Global Financing, which includes financing and used equipment sales.

Currently, IBM’s largest business segment is GTS. Going forward, management is aiming for Cloud & Cognitive Software to become a leading driver of the company’s revenue.

When investors look back at the earlier part of this decade, they may realize that IBM was not fully on top of developments in the tech space. Namely, IBM did not take enough steps to participate in the cloud, an industry that is projected to grow exponentially in the next few years.

Instead, management continued to concentrate on Enterprise IT, whose growth was and likely will be limited. IBM has also blamed external developments for the failure of its turnaround.

IBM’s management has been looking to revitalize the company by making it a dominant force in open source and the cloud. In October 2018, IBM announced that it would acquire Red Hat (NYSE:RHT), a well-respected, open-source, enterprise-software maker for $34 billion.

IBM’s Q3 Results Failed to Impress

Although IBM’s Q3 revenue of $18.0 billion was short of expectations, the company reiterated its earnings and free cash flow guidance for the full year. In terms of the five segments,

  • Cloud & Cognitive Software had revenues of $5.3 billion, up 6.4%;
  • Global Business Services had revenues of $4.1 billion, up 1.0%;
  • Global Technology Services had revenues of revenues of $6.7 billion, down 5.6%;
  • Systems had revenues of $1.5 billion, down 14.7%; and
  • Global Financing had revenues of $343 million, down 11.7%.

Management reported that revenue from Red Hat grew by 20% year-over-year. However, analysts were not impressed with the $371 million in revenue from Red Hat during the quarter.

Rest of the year could prove somewhat bumpy for IBM stock. Don’t forget that IBM paid a hefty premium for Red Hat, and that the deal was one of the largest tech acquisitions of all time. On Aug. 2, IBM had already lowered its 2019 earnings guidance, citing an adjustment to its deferred revenue as a result of the Red Hat deal.

Can IBM Jump-Start Hybrid Cloud Revenue?

Investors are hoping that IBM’s acquisition of Red Hat will put IBM en-route to becoming a leader in the hybrid cloud sphere.

Cloud computing has become a disruptive force in technology. Hybrid cloud environment uses a mix of on-premises, private cloud and third-party cloud services. By 2023, the global hybrid cloud market is expected to reach $138.63 billion.

Well-known for its corporate version of Linux, Red Hat generates a great deal of revenue from the cloud. But will Red Hat improve IBM’s fundamentals?

Red Hat has significant competitive advantages. In several quarters, it may become a catalyst that will contribute to the growth of IBM’s cloud business.

However, a prolonged trade war between the U.S. and China could adversely affect the IBM stock price. Wall Street has also voiced concern that the global economy could be headed for a downturn.

Additionally, IBM now plans to suspend its share buybacks in 2020 and 2021 while it works on decreasing the debt it accumulated from the purchase of Red Hat.

Going forward, investors are likely to pay attention to IBM stock’s margins. If this acquisition does not translate into healthier margins, then the IBM share price could suffer.

Where IBM Stock Price Is Now

From April 2014 to December 2015, the stock price fell from $200 to $120. In February 2017, IBM went back up to $180, only to hit $105.94 in December 2018.

Then came the stock market rally in early 2019, in which IBM too participated. By early June, IBM’s shares were trading around $127.

On Aug. 2, IBM shares reached a 2019-high of $152.95. To the dismay of long-term shareholders, IBM shares suffered for the most part of August. On Aug. 23, IBM hit an intra-day low of $128.83. This low was followed by increased volatility in September and early October.

On Oct. 16, before the release of earnings, IBM closed at $142.11. The shares fell over 3% in extended trading. The next day the stock price closed at $134.26.

According to recent research by the University of Texas, stocks like IBM tend to react considerably to financial news, not only the day the news breaks but for several days afterward, too. Thus, it would not be surprising if IBM shares became even choppier in the near-term as short-term traders try to capitalize on the noise generated by the earnings announcement.

If you are an investor who pays attention to technical charts, during most of the year, IBM has traded within a range of $130-$150.

Currently, the shorter-term IBM stock chart points to further volatility. However, I expect the $120-$125 level to act as support.

The most likely scenario for the rest of the year is that IBM stock will spend considerable time between $125 and $145.

The Bottom Line on IBM Stock

IBM is likely to continue to be choppy in the near-term. If you are a long-term investor who is also interested in IBM stock’s dividends, then you may want to stay the course and ride out any short-term volatility.

Alternatively, you may consider hedging your position. As for hedging strategies, covered calls or put spreads that expire on Dec. 20 could be appropriate, as straight put purchases are likely to be expensive due to the stock’s heightened volatility.

As of this writing, Tezcan Gecgil did not hold a position in any of the aforementioned securities.

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