Better Buy: International Business Machines Corporation vs. Alphabet Inc.

By Tim Brugger Markets Fool.com

Though they play in different sandboxes in most areas, there is one significant similarity between IBM (NYSE: IBM) and Alphabet (NASDAQ: GOOG) (NASDAQ: GOOGL): Both are noted innovators. Alphabet's early forays into self-driving cars, nanotechnologies, and wearables -- among a host of other futuristic endeavors -- have set it apart.

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The notion of IBM as an innovator is more recent, but significant strides in cognitive computing, big data, and cloud analytics has positioned Big Blue on the cutting edge. But the two behemoths are markedly different from an investor's perspective. This makes answering the question of which is the better buy an intriguing one.

Image source: Alphabet.

The case for Alphabet

Alphabet's stock has performed relatively poorly this year, up just 4.5% despite growing at a phenomenal clip, which is particularly impressive given it's one of the largest companies on the planet. Meanwhile, IBM isn't posting revenue gains quarter in and quarter out, yet its stock has shot up over 21% year to date.

A year ago, Alphabet generated $18.68 billion in total revenue, a 13% improvement over 2014's third quarter. And that paled in comparison to 2016's third quarter, in which revenue climbed 20% year over year, to $22.45 billion. The fact Alphabet is gaining sales momentum at its size is largely due to its focus on mobile search and video, a recognized area of weakness a year ago.

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Thanks in part to improving margins, earnings per share soared 27% last quarter despite Alphabet's infamous spending: Both cost of revenue and operating expense increased. However, Alphabet's other revenues skyrocketed 39% in the third quarter, and its "Other Bets" losses narrowed. Alphabet's spending is beginning to pay off, which bodes extremely well for continuing its stellar run.

Image source: IBM.

The case for IBM

Investors and pundits seem to realize that for IBM, total revenue takes a backseat to its "strategic imperatives" results -- which explains why IBM shareholders are enjoying a banner year. Last quarter's $19.2 billion in sales was flat compared to a year ago, when the company posted a solid result compared with the revenue declines of the past.

IBM's strategic imperatives -- which include data security and mobile sales, in addition to the aforementioned cloud, analytics, and cognitive computing -- generated $8 billion in the quarter, up 16% compared to a year ago. CEO Ginni Rometty's focus on the sales of cloud-based software as a service (SaaS) and business process solutions is driving IBM's strong results.

This year cloud-related SaaS and business process revenue is expected to generate over $80 billion, which explains IBM's phenomenal annual run-rate increase of 66% in the third quarter in what it calls cloud as a service. The annual run rate of $7.5 billion in cloud service sales last quarter was nearly a third of IBM's total strategic imperatives revenue of $31.8 billion.

Surprisingly, IBM actually enjoyed a slight decrease in total expense and other income in the third quarter. The spending decline was surprising in that IBM has invested literally billions of dollars in its strategic imperatives this year alone. And then there's the appeal of IBM's 3.4% dividend yield to investors in search of income. By contrast, Alphabet steadfastly refuses to pay a dividend, though it is giving back to shareholders via its recently announced $7 billion stock repurchase plan.

Which is the better buy?

Alphabet should continue to report quarterly sales and earnings that are simply off the charts, but it's become a victim of its own success. When 20% revenue growth and 27% per-share earnings gains warrant little more than a yawn from investors, it calls into question how much upside Alphabet really offers. That said, its stock should slowly but surely climb over the years, just not as much as it has earned based on its financials.

IBM stock isn't likely to skyrocket any time soon, either. But what IBM stock should do is continue its steady climb, translating to more upside than Alphabet over the long haul -- because of the company's strategic imperatives success, and because it had underperformed for so long. Add in a solid dividend and the nod goes to IBM.

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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Tim Brugger has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Alphabet (A shares) and Alphabet (C shares). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.