Better Buy for 2022: IBM vs. Xerox

International Business Machines Corporation (IBM) and Xerox Holdings Corporation (XRX) are two prominent players in the global technology industry. IBM offers application, technology consulting and support, process design and operations, cloud, digital workplace, and network services, as well as business resiliency, strategy, and design solutions. In comparison, XRX designs and develops document management systems and solutions for the banking, education, government, healthcare, manufacturing, and retail industries. It offers workflow automation, enterprise content management, document transaction processing, packaging printing, and managed print services.

The ongoing digitalization across industries, rising funding for cyber security, and the continuation of work-from-home structures should keep the tech products and services in demand in the upcoming months. As investors are worried about Fed’s upcoming interest rate hikes and the stock market is witnessing high volatility, dividend-paying tech stocks are gaining investor attention lately.

Investors’ interest in this space is evident from the First Trust NASDAQ Technology Dividend Index ETF’s (TDIV) 12.4% gains versus the SPDR S&P 500 Trust ETF’s (SPY) 8.6% returns over the past three months. The global information technology market is expected to grow at 9% CAGR and reach $11.87 trillion by 2025. So, both IBM and XRX should benefit.

While XRX has gained 1.7% over the past year, IBM has surged 8.2%. IBM is a clear winner with 3.9% gains versus XRX’s negative returns in terms of the past nine months’ performance. But which of these stocks is a better pick now? Let us find out.

Latest Developments

On January 7, 2022, IBM’s IBM Watson Advertising announced data availability from The Weather Company, an IBM Business, on Amazon.com, Inc.’s (AMZN) AWS Data Exchange platform. By providing weather datasets through AWS Data Exchange in the cloud, IBM Watson Advertising is looking forward to harnessing the relationship between weather and consumer behavior using AI to extract deep insights and help businesses make more confident, data-driven, and insightful enterprise decisions.

IBM paid a $1.64 per share quarterly cash dividend on December 10, 2021. The stock pays a $6.56 per share dividend annually, translating into a 4.91% yield. The company’s dividend has grown at a 3.80% rate over the past five years. 

On December 16, 2021, the Defense Advanced Research Projects Agency (DARPA) awarded a $5.8 million contract to XRX’s PARC company to develop an AI system with the University of California, the University of Rostock, and Patched Reality, a provider of AR and VR development software company, and help users to complete tasks using AR guidance while also monitoring task execution. PARC will be the lead contractor on the “Autonomous Multimodal Ingestion for Goal-Oriented Support” (AMIGOS) project, and the expertise will help XRX develop its CareAR software business.

XRX is scheduled to pay a $0.25 quarterly cash dividend on January 31, 2022. The stock pays a $1 per share dividend annually, which translates to a 4.23% yield. The company’s dividend has grown at a 4.54% rate over the past five years.

Recent Financial Results

IBM’s total revenues for its fiscal 2021 third quarter, ended September 30, 2021, increased marginally year-over-year to $17.62 billion. The company’s non-GAAP gross profit came in at $8.46 billion, indicating a 1.7% decline from the year-ago period. Its non-GAAP pre-tax income from continuing operations came in at $2.40 billion, down 6.8% from the prior-year period. IBM’s non-GAAP net income at $2.29 billion for the quarter, representing a 1.3% year-over-year decline. Its non-GAAP EPS decreased 2.3% year-over-year to $2.52. The company had $7.46 billion in cash and equivalents as of September 30, 2021.

For its fiscal 2021 third quarter ended September 30, 2021, XRX’s adjusted revenues decreased marginally year-over-year to $1.76 billion. The company’s adjusted gross profit came in at $74 million, down 43.5% from the year-ago period. Its adjusted pre-tax income came in at $85 million for the quarter, representing a 36.1% decline from the prior-year period. While its adjusted net income decreased 14.3% year-over-year to $90 million, its adjusted EPS remained unchanged at $0.48. The company had $2.21 billion in cash and cash equivalents as of September 30, 2021.

Past and Expected Financial Performance

IBM’s total assets and levered free cash flow increased at 5.7% and 26.4% CAGR, respectively, over the past three years.

IBM’s EPS is expected to rise 9.5% year-over-year in the fiscal year 2021, ended December 31, 2021, and 5.7% in 2022. The company’s revenue is expected to decrease 6.2% year-over-year in fiscal 2021 and 12.1% in 2022. Analysts expect the company’s EPS to grow at a 6.9% rate per annum over the next five years.

In comparison, XRX’s levered free cash flow increased at a CAGR of 12.6% over the past three years. The company’s total assets have declined at a CAGR of 2.8% over the past three years.

Analysts expect XRX’s EPS to increase 12.1% year-over-year for the fiscal year 2021, ending December 31, 2021, and 26.6% in 2022. Its revenue is expected to grow 1.1% year-over-year in fiscal 2021 and decline marginally in 2022. The company’s EPS is expected to decline at a rate of 16% per annum over the next five years.

Valuation

In terms of non-GAAP P/E, XRX is currently trading at 14.93x, 12.3% higher than IBM’s 13.30x. In terms of forward EV/EBITDA, IBM’s 9.46x compares with XRX’s 9.81x.

Profitability

IBM’s trailing-12-month revenue is almost 10.4 times XRX’s. IBM is also more profitable, with a 21% EBITDA margin versus XRX’s 10.8%.

Furthermore, IBM’s ROE, ROA and ROTC of 21.4%, 3.7% and 6.5%, compare with XRX’s 5.3%, 2.1% and 2.9%, respectively.

POWR Ratings

While IBM has an overall B grade, which translates to Buy in our proprietary POWR Ratings system, XRX has an overall C grade, equating to a Neutral. The POWR Ratings are calculated by considering 118 distinct factors, each weighted to an optimal degree.

Both IBM and XRX have a B grade for Value, in sync with their lower-than-industry valuation ratios. IBM has a 1.71x forward Price/Sales, 57.2% lower than the 3.99x industry average. XRX’s 0.59x forward Price/Sales is 85.1% lower than the industry average of 3.99x.

IBM has a B grade for Quality, consistent with its higher-than-industry profitability ratios. IBM’s 21% trailing-12-month EBITDA margin is 45.9% higher than the 14.4% industry average. XRX has a C grade for Quality, in sync with its lower profitability ratios. XRX has a 10.8% trailing-12-month EBITDA margin, 25.2% lower than the industry average of 14.4%.

Of the 49 stocks in the B-rated Technology - Hardware industry, IBM is ranked #11. On the other hand, XRX is ranked #31 of 77 stocks in the D-rated Technology - Services industry.

Beyond what we have stated above, our POWR Ratings system has also rated IBM and XRX for Growth, Momentum, Stability, and Sentiment. Get all IBM ratings here. Also, click here to see the additional POWR Ratings for XRX.

The Winner

Growing investments and demand in the tech industry should benefit both IBM and XRX. However, relatively lower valuation and higher profitability make IBM a better buy here.

Our research shows that the odds of success increase if one bets on stocks with an Overall POWR Rating of Buy or Strong Buy. Click here to access the top-rated stocks in the Technology - Hardware industry, and here for those in the Technology - Services industry.

IBM shares were trading at $134.93 per share on Thursday afternoon, up $1.34 (+1.00%). Year-to-date, IBM has gained 0.95%, versus a -1.85% rise in the benchmark S&P 500 index during the same period.

Sweta is an investment analyst and journalist with a special interest in finding market inefficiencies. She’s passionate about educating investors, so that they may find success in the stock market.

More...