IBM Outperforms Other Large-Cap Tech Companies in 2022 as Investors Seek Safety Over Growth

While many tech companies saw their stock prices plummet this year, IBM managed to stay in the green. This is despite the fact that IBM is not often described as a "hot" company.

The Nasdaq is having its worst year since 2008. High gas prices, soaring inflation and the Federal Reserve's steady pace of rate increases have punished growth stocks and favored more mature, less volatile names that are viewed as more recession-resistant.

As the economy reopened and consumers returned to many of their old habits, tech names that thrived during the Covid days suffered the most.

So far in 2022, IBM is one of only two U.S. tech companies valued at $50 billion or more to generate positive returns. As of Friday’s close, the stock was up 6% for the year. The other gainer is VMware, which is up 5% because it agreed in May to be acquired by Broadcom for $61 billion.

As some of the biggest tech stocks have taken a beating, investors have been turning to more established companies like IBM and Exxon Mobil. They're betting on these companies' stability and earnings potential, as well as the prospects for the energy and healthcare sectors. Industrial stocks like Northrop Grumman and Lockheed Martin are also seen as attractive options in the current market climate.

According to Bernstein Research analysts, IBM is "trading well above its historical range." The firm has a hold rating on the stock.

IBM is not a growth stock. Expansion is consistently in the single digits, and last year the company spun off Kyndryl, its managed infrastructure services business, into a separate publicly traded entity. That cut head count by about 90,000.

IBM generated $752 million in free cash flow in the latest quarter, up 25% from a year earlier, and paid out $1.5 billion in dividends. Third-quarter earnings and revenue both topped estimates, and the company raised its forecast for the full year. This is good news for IBM shareholders, as the company continues to perform well despite challenging market conditions.

In 2016, Crawford Investment Counsel in Atlanta took a look at IBM and concluded that it would be too early for a major investment, according to Aaron Foresman, an equity analyst at the firm.

In 2019, after IBM bought faster-growing Red Hat for $34 billion, Crawford's thesis changed. The firm, which today has $6.7 billion under management, boosted its IBM stake from $2 million to $30 million and kept buying until its holdings reached $109 million.

Under CEO Arvind Krishna, IBM has taken a hybrid approach to the cloud. After struggling to gain scale as a cloud infrastructure provider, the company has bet that enterprises will use on-premises data center infrastructure as well as the public cloud, rather than relying entirely on one approach or the other.

"Three years later, it is much closer to our vision than everything on public cloud," Foresman said. His firm sold 3% of its shares in the second and third quarter of this year.

Consulting is still a big part of IBM's business, accounting for one-third of its revenue. In that realm, IBM partners with the major cloud providers, rather than competing with them directly. The company has a backlog of business with Microsoft worth more than $1 billion, and an even bigger one with Amazon, IBM CEO Arvind Krishna said in a conversation with RBC CEO Dave McKay in November.

In 2022, IBM introduced the z16 mainframe computer, which represented a significant advance in mainframe technology. When a new mainframe is introduced, many clients upgrade to the new model, which leads to increased hardware revenue for the company. IBM’s prior mainframe boom cycle started in September 2019.

This year, IBM has avoided any major acquisitions, instead opting for smaller deals to bolster specific capabilities. Recently, IBM agreed to purchase Octo, a Virginia-based consulting company that specializes in working with government agencies. No financial details were disclosed. IBM has also acquired the consulting firms Dialexa and Sentaca this year.

Foresman said that the purchases were a good use of capital and that because they were small, the transaction multiples didn't have to be disclosed.

Krishna recognizes that the current economic conditions are not ideal. He said in October that higher prices have led to "some caution creeping into the conversations" in Europe, where the company has to prepare for a potential downturn. In the Americas, where IBM gets about 53% of its revenue, the business climate is "very robust," he said.

The Bernstein analysts said that the stock's direction from here might simply ride on the state of the economy, rather than any major catalyst inside the company.

Analysts believe that IBM's defensive characteristics and historical performance make it likely to do well in pressured markets, and likely to lag behind major indices in a recovery period.

IBM's model for the next five years calls for mid-single-digit revenue growth, which will translate into free cash flow growth in the high single digits.

This is good news for investors who are looking for a safe investment.

"We're expecting mid-single-digit revenue growth, a couple points better than that on EPS, and a 5% dividend yield," Foresman said. "That's not a home run, but it's well within our expectations."

In a recent interview, IBM CEO Arvind Krishna said that technology is a deflationary answer to today's macroeconomic struggles. He noted that technology can help businesses become more efficient and reduce costs, which can ultimately help boost economic growth.