Hendrik Bessembinder’s research on the perfect performing shares of all time is a enjoyable learn. The sixth identify on the record – and the highest performing tech inventory ever – is IBM $IBM. A easy $100 funding in 1926 would have grown to roughly $17.5 million by 2023. That’s a few 13% compound annual development charge in comparison with the inventory market common of round 9% per yr. Nonetheless, over the previous 20 years, the corporate has meaningfully underperformed the S&P 500, even with dividends reinvested. With a brand new CEO coming onboard six years in the past, and two of our tech holdings being acquired by IBM – Confluent and HashiCorp – is Massive Blue lastly beginning to appear like extra development and fewer worth?
IBM’s Massive Turnaround Story
Sometimes we give attention to one metric for development shares that trumps all else: income development. In spite of everything, that’s what tech shares are identified for. Within the case of IBM, it’s a price inventory that dabbles in expertise. An oxymoron. Since we’re holding the inventory due to its dividend development capabilities, we wish to see earnings improve over time as a result of that’s the place our future dividend development will come from. This additionally aligns with how MSCI defines development shares. They use 5 variables, three of which relate to earnings-per-share development. And there are mainly two methods you may improve earnings-per-share – improve revenues or improve profitability.
In the case of income development, IBM is slowly turning across the ship. Under you may see the progress constructed from when the brand new CEO assumed energy in 2020.
Optimistic income development of any form is welcomed following the huge decline seen below the earlier CEO’s tenure. Final yr’s development of 8% was promising contemplating it’s been 18 years since they noticed revenues develop that a lot. Development of solely 5% is anticipated for this coming yr, and Q1 outcomes launched simply days in the past confirmed a touch of promise, beating analyst expectations by a hair over 1%. Nonetheless, the inventory dropped as a result of everybody anticipated annual steering to be raised and it wasn’t. We’re extra occupied with what drove that 8% development final yr as a result of that’s prone to drive development sooner or later as effectively.
What’s Driving IBM’s Development
Whereas it’s true that IBM reported 8% income development in 2025, this quantity is a bit deceptive. When cracking open IBM’s annual report, we discover this useful chart that factors to simply 6% development, not 8%.
That’s on account of “fixed foreign money” reporting. As a world enterprise, IBM earns income in numerous currencies however stories earnings within the good outdated U.S. greenback. When foreign exchange just like the euro strengthen towards the greenback, it means IBM will get extra bang for his or her buck. That’s what occurred in 2025. Nonetheless, the alternative may be true. If the greenback strengthens towards foreign exchange, IBM’s true income in USD will face headwinds.
Moreover, whether or not IBM grew revenues by 6% or 8%, a part of this development was inorganic. Whenever you bolt on an acquisition, you’re not evaluating apples to apples. You’re evaluating two mixed companies in 2025 towards one enterprise in 2024. Organically, IBM’s income was solely stated to have grown 4% in 2025.
Regardless, it’s clear Software program and Infrastructure fueled IBM’s development final yr, in order that’s price digging into. Rising a decrease margin section like consulting won’t have the identical impact as rising a excessive margin section like software program. The under desk helps us perceive precisely why IBM has been so targeted on rising their software program division. It’s propping up their gross margins whereas fueling their income development.
Nonetheless, simply because software program companies include excessive gross margins doesn’t imply they’re essentially extra worthwhile. Neither HashiCorp nor Confluent have been worthwhile on a internet foundation regardless of having robust gross margins. That’s due to one thing known as “stock-based compensation” or SBC. It’s a standard follow with tech corporations, particularly these seeking to develop rapidly. They reward their high-level workers and officers with shares of firm inventory to incentivize them to work tougher. Whereas it’s a non-cash expense, it nonetheless reveals up within the firm’s earnings, which may put stress on IBM’s outcomes.
Particularly IBM is anticipated to owe about $500 million in SBC from the Confluent acquisition, ensuing within the dilution of IBM’s earnings per share by about 3% in 2026 and 2027. Whereas particular particulars on HashiCorp’s SBC stay unknown, IBM possible initiated new payout plans to retain HashiCorp workers. This begs the query, why did IBM make these two massive acquisitions?
HashiCorp was acquired for $6.4 billion in money and closed early final yr. HashiCorp’s instruments have been then built-in into IBM’s Purple Hat suite of software program, creating an “end-to-end hybrid cloud platform.” The “end-to-end’ refers back to the complete lifecycle of an software from improvement to deployment to administration, and ‘hybrid cloud’ merely refers back to the potential to run stated software on a number of environments, whether or not that be a big cloud supplier like AWS, a personal cloud, or an on-premise information middle. IBM appreciated the concept of simplifying workloads for his or her clients in addition to accessing HashiCorp’s group of builders. It’s understanding effectively to this point, already turning into ‘EBITDA accretive’ forward of schedule.
Confluent was acquired for $11 billion and simply closed lower than one quarter in the past. IBM breaks out their Software program division into 4 segments: Hybrid Cloud, Automation, Knowledge, and Transaction Processing. Whereas HashiCorp was instantly focused for the primary two, Confluent is claimed to be helpful to all 4 segments. It was built-in instantly into IBM’s watsonx.information and IBM Z software program instruments from Day 1 after closing on the acquisition. The corporate claims this acquisition will assist clients transfer from “information at relaxation” options the place values is likely to be stale or outdated to “information in movement” the place fields replace repeatedly, enabling new alternatives for AI brokers to work in actual time.
One other development driver for IBM regarding AI is their zSystems enterprise, which in 2025 achieved its highest annual income in twenty years. The brand new z17, launched in April 2025, is marketed as the primary mainframe absolutely engineered for the AI age, that includes the flexibility to course of a whole lot of billions of inference operations day by day instantly on the platform. Whereas the broader Infrastructure section accounted for roughly 21% of complete revenues in Q1 2026, the mainframe portion stays extremely cyclical, with main {hardware} refreshes usually occurring on a 2 to 3-year cycle.
Of their latest earnings name, IBM acknowledged that software program is the “core development engine” for his or her upbeat income targets, so it is smart they’d wish to double down on increasing this space of their enterprise, particularly when Consulting is tough to scale and Infrastructure is extremely cyclical. When you’re questioning why they haven’t spun out their consulting division, it’s most likely as a result of it’s used as a gross sales arm to get shoppers to undertake options from the opposite two segments. Since we’re invested within the firm for dividend development causes, we’d anticipate this robust development to ultimately circulation right down to the corporate’s backside line and be returned to shareholders within the type of dividends.
Working Money Flows and Dividends
We’ll maintain this quite simple. Earnings-per-share or EPS is solely internet revenue (or earnings) divided by the variety of excellent shares. Now you may see why an organization buys again their shares. Even when internet revenue stays the identical, earnings-per-share will improve as a result of you will have fewer shares excellent. Now if we take internet revenue and take away all of the non-cash accounting changes we get working money flows. That is a very powerful quantity as a result of from this we’re capable of pay dividends, purchase development, or presumably pay down debt (extra on debt in a bit). Right here’s a have a look at working money flows over time in comparison with dividends.
Loads of cash to cowl the dividends, so what are they utilizing the surplus money for? Proper now it’s going into making acquisitions to gas development. Because of this dividend development has been so minimal. The precedence is to extend development which may gas dividend will increase sooner or later.
To see whether or not this plan is taking form, buyers can watch IBM’s “payout ratio” which reveals how a lot of an organization’s internet revenue is paid out within the type of dividends. IBM’s at present sits round 60%, rather more sustainable than the 100%+ they have been seeing in 2025. As earnings improve, payout ratio declines, that means IBM ought to proceed to have extra wiggle room to begin bumping up dividends by greater than only one penny per yr. That’s the hope, at the least.
Managing the Debt Load
Most fallen dividend champions droop dividend development as a result of they’re financially unable to maintain their monitor file. Most often we’ve noticed, this comes right down to debt. Final quarter IBM’s complete long-term debt was $57.7 billion. Now we have to contemplate the $10.8 billion in money on their books and we get $46.9 billion in internet long-term debt.
If IBM took all of the working money flows generated over the previous six years leftover after paying dividends, that might give them about $46 billion – almost sufficient to have fully paid off their debt. Having debt isn’t a nasty factor, actually it’s seen as fascinating provided that an organization can use this as leverage to develop their enterprise quicker. Nonetheless, IBM’s debt is steadily growing, with the corporate taking over a further $9.4 billion in 2025 to gas their acquisition spree.
All three main credit standing businesses (Moody’s, S&P, and Fitch) charge IBM within the “single-A” vary, with “triple-A” being the perfect. This implies IBM is taken into account to be on the center to low finish of “funding grade” – a great signal. Whereas IBM’s latest acquisitions prompted S&P to fret about overleveraging dangers, Moody’s and Fitch weren’t involved, anticipating further earnings to offset the influence of the elevated debt load.
All three corporations are at present watching one thing they check with as “core EBITDA leverage” or IBM’s potential to repay their debt utilizing their operational revenue. They wish to see this ratio decline, implying better potential to repay debt. That’s one thing for buyers to observe carefully. After the Confluent acquisition, S&P famous: “Our outlook is detrimental as a result of the acquisition causes leverage to strategy our downgrade set off of above 2.5x and additional acquisitions may maintain leverage elevated.” Whereas that quantity at present sits above 2.5x (at present 3.2x if you happen to use internet debt of $58 billion divided by core EBITDA of $17.6 billion), S&P has not downgraded the agency but. They go on to say that they’re watching for 3 issues to occur to keep away from a downgrade: a “digestion interval” of decrease spending to scale back leverage, sustained income development and margin enlargement, and a continued suspension of share repurchases to give attention to paying down debt. If these three issues occur, IBM’s credit standing needs to be protected, and buyers can breathe a small sigh of aid.
Conclusion
Our unique determination to carry IBM surrounded a need to have illustration throughout all sectors. Even right now, the expertise sector has nearly nothing to select from, although Microsoft $MSFT and Qualcomm $QCOM are upcoming champions which may very well be extra compelling than Massive Blue. Nonetheless, we follow our guidelines. We solely ever promote a dividend champion in the event that they cease growing their dividend. IBM’s dividend is in little hazard, and the corporate is exhibiting some promise in restoring development. In the event that they’re capable of eat their very own pet food, then we’d anticipate they use the powers of AI to extend their margins as effectively. We’re extra excited concerning the firm’s prospects going ahead however nonetheless aren’t satisfied they’ve shed that fame of all the time chasing relevancy, not main the cost.
