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Microsoft vs. IBM: Which Tech Stock is a Better Buy?

Many software and cloud-based tech companies have experienced major growth this year. However, Microsoft (MSFT) has outperformed International Business Machines (IBM) by a significant margin. IBM has been increasing its investment in cloud-based AI and machine learning. Find out if this makes it a better buy going forward. 

Microsoft Corporation (MSFT) and International Business Machines Corporation (IBM), two of the world’s biggest tech companies, have continued to prove their worth and resilience during market volatility amid the coronavirus pandemic. As organizations’ affinity for cloud-based platforms is on the rise, these companies are expected to grow steadily in the upcoming months.

MSFT gained 38.6% over the past year, while IBM declined 8% over this period. In terms of past six-month performance, MSFT is the clear winner with 14.1% gains versus IBM’s 1.3% returns. But which of these stocks is a better pick now? Let’s find out.

Latest Movements

On December 10th, MSFT and Deutsche Telekom Group announced a seven-year strategic partnership to help enterprise and customers accelerate digitalization and enhance productivity. This will enable MSFT to accelerate innovation and deliver high-quality services based on customer demands.

The company has recently collaborated with Johnson Controls to digitally transform how buildings and spaces are conceived, built, and managed. MSFT also announced the availability of Microsoft Azure Digital Twins to support the entire ecosystem of building and device management technologies. This will allow MSFT to better meet the evolving needs of its customers.

On December 11th, IBM announced a collaboration with Amazon.com, Inc. (AMZN) to use its Web Services (AWS) platform to help clients simplify and extend their security visibility. This will help IBM provide a more seamless client experience and drive greater return over the long-run.

The company has recently launched new innovative capabilities for IBM Watson designed to help scale the use of AI by businesses. This will help IBM advance in its AI business strategy and enhance its customer service.

Recent Financial Results

In the fiscal first quarter ended September 2020, MSFT’s revenue surged 12% year-over-year to $37.20 billion, primarily due to a rise in intelligent cloud services revenue. The company’s EPS grew 31.9% year-over-year to $1.82.

MSFT’s Office Commercial products and cloud services revenue increased 9% driven by Office 365 Commercial revenue growth. The company’s operating income rose 25% from the year-ago value to $15.90 billion. Moreover, it saw a 30% rise in its Xbox content and services.

IBM’s cloud and cognitive software revenue grew 7% year-over-year to $5.60 billion in the third quarter ended in September 2020. The company’s cloud revenue grew 9% year-over-year. IBM’s EPS rose slightly from the year-ago value to $1.89 over this period.

Thus, MSFT is in an advantageous position here.

Past and Expected Financial Performance

MSFT’s total assets grew at a CAGR of 6.5% over the past 3 years. The company’s leveraged free cash flow grew at a CAGR of 34.4% over this period.

Analysts expect the company’s revenue to increase by 11.1% next year. MSFT’s EPS is expected to grow 10.5% next year.

On the other hand, IBM’s total assets grew at a CAGR of 8.2% over the past 3 years. The CAGR of the company’s leveraged free cash flow has been 26.3%.

Analysts expect the company’s revenue to increase by 1.2% next year. IBM’s EPS is expected to grow 38.2% the next year.

Profitability      

MSFT’s trailing-12-month revenue is 1.96 times of what IBM generates. MSFT is also more profitable with a gross profit margin of 68.3% versus IBM’s 48.2%.

Moreover, MSFT’s ROE and ROA of 41.4% and 12.1% compare favorably with IBM’s 40.1% and 3.7%, respectively.

Valuation

In terms of forward P/E, MSFT is currently trading at 31.75x, 55% more expensive than IBM which is currently trading at 20.49x. Though MSFT is less expensive in terms of forward PEG (2.67x versus 7.79x), its trailing-12-month Price/Sales of 11.06x is much higher than IBM’s 1.46x.

In terms of trailing-12-month price/cash flow as well, MSFT’s 24.47x is 251.1% higher than IBM’s 6.97x.

Though MSFT looks much more expensive compared to IBM, this premium valuation is justified considering its higher earnings growth potential.

POWR Ratings

Both MSFT and IBM are rated “Buy” in our proprietary POWR Ratings system. Here are how the four components of overall POWR Rating are graded for MSFT and IBM:

MSFT has an “A” for Trade Grade and Industry Rank, a “B” for Buy & Hold Grade, and a “C” for Peer Grade. In the 98-stock Software - Application industry, it is ranked #31.

IBM has an “A” for Trade Grade and Industry Rank, and a “C” for Buy & Hold Grade and Peer Grade. It is ranked #14 out of 30 stocks in the Technology - Hardware industry.

The Winner

Both MSFT and IBM are good investment bets considering their market dominance and continued expansion. However, MSFT appears to be a better buy despite trading at a higher valuation based on its higher revenue and earnings growth potential.

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MSFT shares were trading at $213.16 per share on Tuesday afternoon, down $1.04 (-0.49%). Year-to-date, MSFT has gained 36.60%, versus a 16.27% rise in the benchmark S&P 500 index during the same period.



About the Author: Imon Ghosh

Imon is an investment analyst and journalist with an enthusiasm for financial research and writing. She began her career at Kantar IMRB, a leading market research and consumer consulting organization.

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