Over the past decade, IBM's (NYSE: IBM) stock price rose 10% while Microsoft's (NASDAQ: MSFT) stock surged 810%. IBM underperformed Microsoft by such a wide margin because it missed the seismic shift toward public cloud services, struggled to grow its revenue, and prioritized cost-cutting strategies and buybacks over smart investments. Microsoft grew a lot faster by shrewdly expanding its cloud, mobile, and AI ecosystems.
Microsoft might still seem like a better buy than IBM right now, but the stock of the former actually underperformed the latter over the past 12 months. Microsoft's stock is up 24%, while IBM's stock advanced 36% as it impressed the bulls with its stabilizing growth.
Could IBM continue to outperform Microsoft over the next 12 months?
Image source: Getty Images.
How IBM started to grow again
From 2012 to 2021, IBM's revenue fell from $102.9 billion to $57.4 billion. That steep decline was caused by the market's soft demand for its business software and IT services, and it was exacerbated by the divestitures of its x86 server, PC, marketing cloud, and other large businesses. Those divestments and other cost-cutting measures generated more cash for buybacks and briefly lifted its earnings, but they ultimately hampered the expansion of its cloud, mobile, and AI services.
But under Arvind Krishna, IBM's former cloud chief who took the helm as its CEO in 2020, the aging tech giant gradually stabilized its revenue and earnings growth. It achieved that elusive goal by trimming its non-core businesses, spinning off its slow-growth managed IT services division as Kyndryl(NYSE: KD), and expanding its open-source software subsidiary Red Hat to develop more hybrid cloud and AI services.
Instead of trying to catch up to Amazon, Microsoft, and Alphabet's Google in the public cloud race, IBM tapped Red Hat's open-source technology to develop cross-compatible AI services that could be wedged between a wide range of private and public clouds. As a result, IBM's revenue grew 6% in 2022 and 2% in 2023.
From 2023 to 2026, analysts expect its revenue to increase at a compound annual growth rate (CAGR) of 4% as its earnings per share (EPS) rises at a CAGR of 7%. Those growth rates might seem sluggish, but they indicate it's finally turning a corner. Its stock still looks reasonably valued at 19 times forward earnings and pays an attractive forward yield of 3.3%.
Microsoft needs to maintain its momentum
From fiscal 2014 to fiscal 2024 (which ended this June), Microsoft's annual revenue grew at a CAGR of 11% from $86.8 billion to $245.1 billion as its EPS increased at a CAGR of 16%. That rapid growth largely occurred after its former cloud chief, Satya Nadella, took over as the tech giant's CEO in 2014.
Under Nadella, Microsoft prioritized the expansion of its cloud, mobile, and AI ecosystems. It transformed its productivity software into sticky cloud-based services, expanded Azure into the world's second-largest cloud infrastructure platform, and turned Windows into a central hub for its cloud, mobile, and AI services.
Instead of chasing Apple and Google in the mobile race with new first-party devices, Microsoft rolled out more mobile versions of its desktop apps for iOS and Android devices. It also ramped up its investments in OpenAI, the creator of ChatGPT, and integrated its generative AI tools into its own cloud-based services. As Microsoft expanded its core software ecosystems, it launched more Surface devices and acquired more gaming companies to support the growth of its Xbox business.
That diverse and forward-thinking strategy transformed Microsoft from a mature tech company into a high-growth one again. From fiscal 2024 to fiscal 2027, analysts expect its revenue and EPS to rise at a CAGR of 14% and 15%, respectively. Those growth rates are impressive, but its stock isn't cheap at 31 times forward earnings. Its tiny forward dividend yield of 0.7% also probably won't attract any serious income investors.
The better buy (for now): IBM
Microsoft is still a solid long-term investment, but it could underperform IBM over the next 12 months for two reasons. First, declining interest rates might drive more investors back toward cheap dividend stocks with high yields, like IBM. Second, Microsoft's closely watched Azure sales growth decelerated in its latest quarter, and that slowdown might cause it to lose its luster as a high-growth cloud and AI play. So until Microsoft's valuations cool off a bit more, IBM will remain a better buy.
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John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Leo Sun has positions in Amazon and Apple. The Motley Fool has positions in and recommends Alphabet, Amazon, Apple, and Microsoft. The Motley Fool recommends International Business Machines and recommends the following options: long January 2026 $395 calls on Microsoft and short January 2026 $405 calls on Microsoft. The Motley Fool has a disclosure policy.
