TipRanks Smart Value #53: Hidden Blue
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Dear Investors,
Dear Investors,
Welcome to the 53rd edition of our TipRanks Smart Value Newsletter!
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This Week’s Top Value Pick: International Business Machines Corp. (IBM)
International Business Machines Corp. (IBM) is a U.S.-based technology company that provides enterprise software, hybrid cloud infrastructure, and consulting services to businesses and governments worldwide. Its operations focus on hybrid cloud platforms, artificial intelligence solutions through its Watson portfolio, IT consulting, and infrastructure systems, including servers and storage. IBM is a long-established enterprise technology provider and a key player in hybrid cloud and AI-driven business solutions.
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Reinventing IBM
IBM traces its origins to 1911, when it was formed as the Computing-Tabulating-Recording Company (C-T-R), a consolidation of several firms that produced tabulating machines, industrial time recorders, and commercial scales. These early technologies helped businesses and governments process records more efficiently. In 1924, the company adopted the name International Business Machines, reflecting broader global ambitions and a growing focus on applying technology to business operations.
The company’s growth accelerated in the mid-20th century as it became a dominant force in computing hardware. The company pioneered large-scale mainframe systems that enabled enterprises to automate accounting, inventory management, and complex calculations. Heavy investment in research and development during the 1950s and 1960s led to the launch of the IBM System/360, a landmark platform that standardized computing architecture across machines. The success of System/360 cemented IBM’s leadership in enterprise computing and supported decades of revenue expansion.
As the technology landscape evolved, IBM repeatedly reshaped its business model. In the 1990s, the company began shifting away from a hardware-centric structure toward services and enterprise solutions. The expansion of IBM Global Services allowed IBM to offer IT outsourcing, consulting, and systems integration, creating more stable and recurring revenue streams as personal computers became commoditized and industry competition intensified.
During the 2000s and 2010s, IBM continued repositioning itself toward higher-value technology segments. The company divested several lower-margin hardware businesses while increasing investment in software, analytics, and enterprise middleware. In 2014, IBM sold its System x86 server business to Lenovo while retaining higher-value platforms such as mainframes and Power servers. That same year, the company transferred its semiconductor manufacturing operations to GlobalFoundries, agreeing to pay about $1.5 billion over three years while securing a long-term supply agreement for advanced processors.
IBM streamlined its operations in the early 2020s by divesting several non-core businesses to sharpen its focus on software, consulting, and hybrid cloud platforms. In 2021, the company spun off its managed infrastructure services business as Kyndryl Holdings, allowing IBM to focus more heavily on software, consulting, and hybrid cloud platforms. In 2022, IBM sold much of its Watson Health data and analytics business to Francisco Partners and later agreed to sell The Weather Company’s data and technology assets (originally acquired in 2016) to the same firm.
A major strategic shift occurred in 2019 when IBM completed its largest acquisition, purchasing Red Hat for about $34 billion in cash. The transaction positioned IBM as a major hybrid cloud provider by integrating Red Hat’s open-source technologies, particularly Red Hat OpenShift, which enables companies to build and manage applications across multiple cloud environments.
In recent years, acquisitions have played an increasingly important role in expanding IBM’s software capabilities. The company typically targets deals that are roughly 75% software and 25% services, complement its existing ecosystem, and become free-cash-flow accretive within two years. Looking ahead, IBM is expected to continue prioritizing acquisitions that strengthen automation, data platforms, and technologies linked to the Red Hat ecosystem while remaining selective as it integrates recent deals.
In 2024, the company acquired HashiCorp, a provider of infrastructure automation tools widely used by developers to manage complex cloud environments. IBM has since begun integrating HashiCorp’s technology with its own automation platforms, including capabilities such as Hashi Infragraph, which maps infrastructure relationships and helps identify the root causes of system failures.
Additional acquisitions, including Apptio, Software AG, and DataStax, have strengthened IBM’s capabilities in areas such as technology cost management, enterprise integration, and AI data platforms. When combined with IBM’s global consulting network and enterprise sales relationships, these technologies create cross-selling opportunities that can expand revenue while improving operating efficiency.
One of the most significant recent initiatives is IBM’s planned acquisition of Confluent, announced in late 2025. Confluent develops a real-time data streaming platform built on Apache Kafka, which enables companies to process data continuously across systems rather than in periodic batches. This capability is increasingly important for artificial intelligence applications that rely on constant streams of real-time data.
The transaction is expected to close around mid-2026. IBM estimates the deal will reduce earnings by about $600 million in 2026 due to stock-based compensation and financing costs. However, management expects the acquisition to begin contributing positively to adjusted EBITDA in the first full year after closing and to free cash flow the year after. Over time, IBM also expects approximately $500 million in annual operating expense synergies by the end of 2027, largely from integrating Confluent’s products into its global go-to-market network.
Taken together, these strategic moves illustrate IBM’s long-term transformation from a hardware-dominated manufacturer into a software- and services-focused enterprise technology provider. By concentrating on hybrid cloud, artificial intelligence, and consulting, supported by platforms such as Red Hat, IBM has positioned itself to benefit from long-term growth in enterprise digital transformation and data-driven computing.
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Enterprise Backbone
IBM generates revenue through a diversified enterprise technology portfolio built around software, consulting services, and infrastructure systems. The company’s strategy centers on hybrid cloud and artificial intelligence, which increasingly shape how enterprises modernize their technology environments and manage data-driven operations.
The largest and most profitable part of IBM’s business is its Software segment, which accounts for roughly 45% of total revenue. This division provides hybrid cloud platforms and enterprise software that help organizations automate processes, manage data, and operate mission-critical applications. The portfolio includes open-source hybrid cloud technologies from Red Hat, AI and data platforms, automation tools, and transaction-processing software widely used in industries such as banking, airlines, and retail. Many of these products are delivered through subscription or recurring licensing models, creating a growing base of predictable revenue and relatively high margins.
IBM Consulting represents another major revenue stream. This division helps organizations design, implement, and operate complex technology transformations, including migrating applications to hybrid cloud architectures, integrating enterprise data platforms, and embedding artificial intelligence into business workflows. By combining advisory expertise with IBM’s technology stack and partner ecosystems, consulting engagements frequently lead to long-term managed services contracts and deeper client relationships.
The company also generates revenue through its Infrastructure segment, which includes enterprise servers, storage systems, and mainframe platforms such as IBM Z. These systems remain deeply embedded in industries such as finance, government, and telecommunications, where organizations rely on them for high-volume, mission-critical transaction processing. Infrastructure revenue benefits from long product cycles as well as ongoing maintenance and support services that provide recurring income over time.
IBM also offers financing solutions that help clients acquire hardware, software, and services, enabling large technology deployments while supporting overall sales growth. Together, this integrated model, combining software platforms, consulting expertise, and mission-critical infrastructure, creates a reinforcing ecosystem in which innovation in one area often stimulates demand in others.
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AI Flywheel
IBM describes its strategy as a “flywheel,” in which client trust, open technology platforms, innovation, industry expertise, and a broad partner ecosystem strengthen one another over time. This model has helped the company build long-standing relationships with large enterprises that depend on IBM for critical infrastructure and complex technology operations. In recent years, the flywheel has accelerated as artificial intelligence, hybrid cloud computing, and targeted acquisitions expand the scope of IBM’s platform.
Artificial intelligence has become a central element of this strategy. Rather than positioning AI as a standalone product, IBM has embedded AI capabilities across its software and consulting portfolio. Consulting engagements illustrate this shift, with generative AI projects representing more than one-third of new consulting bookings and contributing over 15% of the company’s revenue run rate. Overall, IBM’s cumulative generative AI book of business has surpassed $12.5 billion, with the largest quarterly increase recorded in the most recent reporting period.
Several platforms support this AI strategy. IBM’s watsonx combines data management, machine-learning models, and governance tools designed for enterprise use. The company also offers IBM watsonx Orchestrate, which allows organizations to deploy AI agents that automate workflows and operational decisions. These capabilities are supported by IBM’s Granite foundation models and by Red Hat’s hybrid cloud platform, which enables enterprises to run AI applications across both private infrastructure and public cloud environments. The company’s approach emphasizes smaller, efficient AI models that can operate securely within enterprise systems while still supporting third-party models from providers such as Hugging Face and Mistral AI.
IBM’s ecosystem of technology partners further strengthens this platform. The company collaborates with major technology providers including Advanced Micro Devices, Anthropic, Amazon Web Services, Microsoft, OpenAI, and Oracle Corporation. These partnerships allow the company’s clients to access multiple AI models and cloud environments while relying on IBM’s hybrid infrastructure to manage workloads across systems.
Innovation continues to play a key role in sustaining this strategy. One major example is IBM’s newest mainframe generation, the IBM z17, which is designed to support modern AI workloads directly within enterprise infrastructure. The system includes specialized hardware that enables real-time AI inferencing alongside high-volume transactions, allowing companies to analyze data and trigger automated actions within milliseconds. Complementing the platform are Spyre accelerator cards that process AI workloads alongside operational systems, reducing latency and embedding intelligence directly into enterprise infrastructure. The z17 also incorporates quantum-safe cryptography designed to protect sensitive data from potential future threats posed by quantum computing.
At the same time, IBM continues to invest in long-term technologies such as quantum computing. The company has already deployed its 120-qubit Nighthawk quantum processor and is working toward a fault-tolerant quantum system later in the decade. Although commercial applications remain in the early stages, organizations such as Cisco Systems and the U.S. Department of Energy are collaborating with IBM to explore applications in materials science, optimization, and advanced simulations. Research programs from the Defense Advanced Research Projects Agency are also supporting efforts to develop scalable quantum architectures.
These investments align with broader structural changes in enterprise technology. As organizations process larger volumes of data, modernize legacy systems, and strengthen cybersecurity frameworks, hybrid cloud infrastructure and AI platforms are increasingly viewed as core technology layers rather than optional tools. This shift continues to support steady demand for IBM’s integrated solutions.
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Growth Engines
Within this environment, IBM’s software segment has emerged as the company’s primary growth engine. The business is expanding at a double-digit pace overall, with more than 75% of its product categories growing at similar rates. This broad growth reduces reliance on any single product line and creates a more resilient revenue base.
Within the segment, Red Hat remains a central pillar of IBM’s strategy. Its Linux operating system continues gaining market share in enterprise data centers, while the OpenShift platform has been expanding at roughly 30% annually. Although government spending cycles have slowed some near-term demand, commercial enterprise adoption remains strong.
Other software categories are also growing rapidly. IBM’s automation software, which helps organizations manage IT infrastructure and streamline workflows, is expanding at a low-double-digit rate and could benefit further from integration with technology from HashiCorp. At the same time, IBM’s data and AI software portfolio is growing even faster, with revenue increasing at high-teen percentages as enterprises deploy platforms such as watsonx and Orchestrate to organize data, train AI models, and automate decision-making processes.
IBM’s consulting segment is expected to deliver modest but steady growth supported by a large backlog of enterprise transformation projects. Backlog represents signed contracts that have not yet been delivered, and as these projects move into implementation phases, revenue is typically recognized. Artificial intelligence is becoming a major driver of consulting demand, with generative AI projects now representing more than one-quarter of the consulting backlog and more than 400 new generative AI clients added.
Consulting profitability is also improving as IBM shifts toward a “services-as-software” model. Platforms such as IBM Consulting Advantage integrate generative AI with the company’s internal knowledge base to accelerate tasks such as software development, application modernization, and process transformation. By embedding technology into consulting projects, IBM reduces labor intensity and improves efficiency, contributing to expanding operating margins.
Finally, the infrastructure segment, particularly IBM’s mainframe platform, continues to provide stable long-term earnings. Mainframes remain essential for industries such as banking, payments, airlines, and government services that require exceptional reliability and transaction capacity. Structural trends such as data sovereignty also support continued demand, as many organizations prefer to keep sensitive information within controlled infrastructure rather than relying entirely on public cloud platforms.
The newest generation system, the IBM z17, has outperformed its predecessor during its first three quarters on the market and offers significantly expanded AI capabilities, delivering roughly 50% more AI inference capacity than the prior IBM z16. Hybrid infrastructure products, which integrate on-premise systems with cloud environments, grew 24% in the fourth quarter, while distributed infrastructure remained roughly flat as stronger demand for Power servers offset softer storage sales.
Although hardware revenue tends to follow cyclical patterns tied to new product launches, the broader economic impact of a new mainframe generation extends beyond hardware sales. As companies adopt the z17 platform, they often increase spending on transaction-processing software and related services, which can drive additional revenue growth several quarters after the initial hardware deployment.
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Earnings Power
IBM has delivered steady financial improvement in recent years as the company continues shifting toward higher-margin software, artificial intelligence, and hybrid cloud solutions. Over the past five years, revenue and earnings per share have grown at compound annual rates of 4.1% and 12.4%, respectively. This performance reflects a combination of software-driven revenue growth, stronger margins from AI and automation products, periodic mainframe upgrade cycles, and ongoing portfolio simplification.
The company reported particularly strong results in 2025. Revenue grew 6% at constant currency to $67.5 billion, exceeding the company’s initial guidance of at least 5%. Growth accelerated in the fourth quarter, when revenue increased 9% year over year to $19.7 billion, marking the fastest quarterly growth rate in more than three years. As artificial intelligence capabilities became increasingly embedded across IBM’s products and services, management indicated it would no longer report standalone generative AI metrics, emphasizing that AI is now integrated throughout the company’s portfolio.
Profitability also improved meaningfully during the year. Operating pretax margin expanded by roughly 100 basis points to 18.8%, about double the company’s original expectation, supported by a richer mix of software revenue and ongoing productivity initiatives. Adjusted EBITDA rose 17% year-over-year to $19.2 billion, adding approximately $2.8 billion in incremental profit and producing the highest operating gross margin in IBM’s history.
Free cash flow remained one of the company’s strongest financial metrics. IBM generated $14.7 billion in free cash flow during 2025, roughly $2 billion above guidance and 16% higher than the prior year. This represented the highest free cash flow margin in the company’s 114-year history and an improvement of about $5.5 billion since 2022. Operating diluted earnings per share rose 12% to $11.59, reflecting operating leverage as the higher-margin software segment contributed roughly two-thirds of the company’s total profits.
IBM’s balance sheet remained stable despite continued investment in acquisitions. At year-end, the company held $14.5 billion in cash and $61.3 billion in total debt, including approximately $15.1 billion associated with its financing business, which is largely backed by investment-grade receivables. During the year, IBM deployed $8.3 billion toward acquisitions while maintaining strong liquidity.
The company’s debt-to-EBITDA ratio stood at approximately 3.7x, higher than the sector median. However, this reflects a deliberate capital allocation strategy that includes financing transformative acquisitions such as Red Hat and HashiCorp, while also supporting IBM’s internal financing unit that lends to customers purchasing IBM products. Strong free cash flow generation and the company’s growing mix of recurring software and consulting revenue help support this level of leverage. Credit rating agencies continue to view the balance sheet as stable, with long-term ratings of “A3” from Moody’s and “A-” from both S&P and Fitch.
Another important driver of profitability has been IBM’s cost productivity program. By the end of 2025, the company had achieved an annualized savings run rate of $4.5 billion, significantly exceeding the $2 billion target originally set for the end of 2024. Management expects an additional $1 billion in savings during 2026, which would increase the annual run rate to approximately $5.5 billion.
These improvements were also reflected in the performance of IBM’s three core operating segments, Software, Consulting, and Infrastructure, each of which contributed to the company’s overall growth and margin expansion.
The Software segment remained the company’s primary growth engine. Revenue grew 9% in constant currency during 2025, reaching a record $30 billion, while fourth-quarter growth accelerated to 11%. Within the segment, several subcategories performed particularly well. The Data business, which includes AI-driven analytics platforms, rose 19% in the fourth quarter as enterprise demand for generative AI solutions increased. Automation software grew 14% in the quarter, supported by strong customer interest following IBM’s acquisition of HashiCorp, which drove record bookings for tools used to manage and secure complex cloud environments.
Red Hat, IBM’s flagship hybrid cloud platform, continued to expand with 8% growth in the fourth quarter. Adoption of Red Hat OpenShift remained particularly strong, with annual recurring revenue reaching $1.9 billion, up 30% year over year. Overall, Software’s annual recurring revenue reached $23.6 billion, an increase of roughly $2 billion from the prior year, while profit margins improved by about one percentage point.
After a slower start to the year, IBM Consulting returned to growth in the second half of 2025, posting a modest 1% increase in the fourth quarter. Demand for AI-related consulting also accelerated significantly. IBM reported that the cumulative value of generative AI consulting engagements exceeded $10.5 billion, including more than $2 billion added during the fourth quarter alone, the largest quarterly increase to date.
Although consulting signings declined year over year due to a difficult comparison with a record fourth quarter in 2024, the quality of deals improved as the company secured more strategic contracts related to AI, cybersecurity, and application modernization. The consulting backlog remained strong at $32 billion, growing 2% year over year. Profitability also improved, with margins expanding by 180 basis points, the strongest improvement in three years, reflecting a shift away from lower-margin business process outsourcing toward higher-value advisory and technology services.
IBM’s Infrastructure segment also delivered strong results during the year, supported by the latest mainframe upgrade cycle. The segment grew 10% for the full year and accelerated to 17% growth in the fourth quarter. Revenue from the IBM Z platform increased 48% during the year and surged 61% in the fourth quarter, marking the strongest fourth-quarter performance for the mainframe business in more than two decades. Infrastructure profitability improved the most among IBM’s segments, with margins expanding by about 450 basis points.
Across the Software segment, three of four major subsegments delivered double-digit growth for the year, while the new mainframe cycle boosted infrastructure demand. At the same time, Consulting continued shifting toward higher-growth areas such as AI, cybersecurity, and application modernization. The company’s returns on capital also remain strong, with ROE, ROA, and ROIC ranking in roughly the top 10%, 20%, and 30% of the industry, respectively.
Looking ahead to 2026, IBM expects revenue to grow by more than 5% year over year, while free cash flow is projected to increase by approximately $1 billion.
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Blue Upside
IBM’s shares surged through 2025 and early 2026, reaching a 52-week high of $324.90 in November on optimism around its watsonx AI platform and hybrid-cloud strategy, but fell around 13% on February 23, 2026 after Anthropic introduced tools that they company claimed could automate COBOL modernization. COBOL, a programming language from the 1950s, still powers critical backend systems across banking, insurance, government, and airlines, largely running on IBM mainframes. These systems generate significant recurring revenue for IBM through hardware, software licensing, maintenance, consulting, and a deeply embedded ecosystem. Historically, moving away from COBOL has been costly, complex, and risky, with limited available expertise. Despite the sharp decline, analysts believe the disruption risk is limited, noting that IBM’s mainframes remain highly optimized for transaction processing, and new AI tools could actually extend COBOL systems’ lifespan by helping transfer knowledge as experienced developers retire.
Jefferies also highlighted that IBM is proactively modernizing these systems through watsonx Code Assistant for Z, which uses generative AI directly into the mainframe to refactor COBOL into Java and update applications with full system context. IBM’s management further emphasized that modernizing enterprise platforms involves far more than translating code, as the architecture of the mainframe platform itself remains the core source of its value.
IBM’s current valuation appears to reflect its positioning as a stable, cash-generative enterprise technology company with moderate growth expectations, setting the stage for a closer look at how the stock compares with broader sector valuation metrics. On several measures – including trailing and forward non-GAAP price-to-earnings ratios, forward price-to-cash-flow multiples – the stock is trading at a discount to sector averages.
A comparison with major technology peers reinforces this point. Relative to companies such as Amazon, Alphabet, Microsoft, and Oracle, IBM generally trades in the low-to-moderate range across several forward valuation metrics, including P/E, EV/EBITDA, price-to-book, and price-to-cash-flow ratios. This suggests the market continues to value IBM as a stable enterprise technology provider rather than a high-growth platform company, while still recognizing its profitability and large installed customer base.
For long-term value investors, this dynamic suggests IBM’s valuation may not fully capture the potential benefits of its ongoing transformation. Over time, when investments in hybrid cloud, automation, and AI platforms translate into stronger revenue and earnings growth over time, the company should see further valuation expansion alongside its stable cash-flow generation.
Analysts also point to IBM’s strong profitability and dependable cash generation as key pillars of the bullish case, with the company producing roughly $13.2 billion in trailing twelve-month free cash flow. This provides financial flexibility to fund reinvestment, dividends, and debt reduction even if growth moderates. At the same time, the company’s expanding software business is increasing revenue predictability and strengthening margins as demand grows for AI and hybrid-cloud platforms. Productivity initiatives and a higher mix of software revenue are also driving efficiency gains, with pretax margins improving and adjusted EBITDA rising year over year, supporting stronger cash-flow potential over the medium term.
Street consensus implies roughly 32% upside from the current share price, while more bullish forecasts suggest potential gains of up to 50%. The dispersion in analyst price targets reflects differing views on the pace at which IBM’s hybrid-cloud and AI initiatives could drive future growth. While some analysts remain cautious given the company’s mature business segments, others see meaningful upside if its expanding software and AI platforms continue gaining traction. This view is supported by discounted cash-flow analysis indicating that IBM’s shares may be trading at an estimated 33% discount to intrinsic value.
IBM has been paying dividends consistently since 1916 and is a Dividend Aristocrat, having increased its dividend for 30 consecutive years. Over the past decade, the dividend has grown at an annual rate of about 2.21%, and the company distributes roughly 58% of adjusted earnings to shareholders. Its dividend yield of 2.21% is higher than the technology sector average of 1.07%. For the most recent quarter, the company declared a regular quarterly cash dividend of $1.68 per common share to stockholders of record on February 10, 2026.
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Investing Takeaway
For long-term investors, IBM represents a rare combination of stability and transformation within the technology sector. The market continues to view the company primarily as a mature enterprise provider, which has kept its valuation relatively restrained compared with many large technology peers. Yet beneath that perception, IBM has been steadily reshaping its business toward higher-margin software, artificial intelligence platforms, and hybrid cloud infrastructure. These areas are becoming increasingly central to enterprise computing and could support stronger growth over time. Meanwhile, the company’s durable enterprise relationships, recurring revenue streams, and consistent cash generation provide a foundation that reduces downside risk. For value-oriented investors, IBM offers exposure to long-term technology trends while still trading like a defensive cash-flow business, creating the potential for gradual valuation expansion as its transformation continues.
