While a profit metric like net income shouldn’t be ignored, it’s ultimately an accounting figure. Free cash flow, which is the amount of cash a business generates from operations after subtracting capital expenditures, is what fuels growth investments, dividend payments, share buybacks, and debt reduction. You can’t spend net income.
Investing in companies that are solid cash flow producers is often a good idea, assuming the price is reasonable. Two cash flow machines that trade at pessimistic valuations are AT&T (T 1.13%) and IBM (IBM -0.92%). Both stocks look like bargains.
With Apple‘s iPhone 15 family officially announced, the major wireless carriers are using promotions to attract new customers and retain existing customers. AT&T, for example, is offering as much as $1,000 off the iPhone 15 Pro with an eligible trade-in for customers on its Unlimited plans.
While this promotional activity appears aggressive, AT&T CFO Pascal Desroches noted during a recent conference that promotional activity is largely unchanged across the industry. “I would characterize the environment as really healthy. The competitive dynamics is very, very healthy, very rational,” Desroches said.
During the same conference, Desroches reiterated AT&T’s guidance calling for at least $16 billion of free cash flow this year, even as subscriber gains have slowed. Free cash flow could move higher in 2024 and beyond as AT&T pulls back a bit on capital spending. The company has been investing heavily in its 5G and fiber networks, pushing capital spending up. This year is expected to mark the peak of that spending.
AT&T is valued at about $109 billion. Based on the free cash guidance, the stock’s price-to-free-cash-flow ratio is around 6.8. That’s an extremely pessimistic valuation. AT&T stock certainly doesn’t deserve to trade at a premium: Growth will be slow at best, debt levels are still elevated, and competitive pressures could ramp up if economic conditions deteriorate. But the pessimism seems overdone.
AT&T stock trades lower than it did during the dot-com bubble, the financial crisis, and the pandemic. For patient investors, this cash flow machine looks like a bargain.
While IBM is a complex company that spans hardware, software, and services, the tech giant ultimately offers customers solutions that aim to boost productivity and cut costs. In a tough and uncertain economy, that pitch should resonate with customers.
IBM’s cloud strategy is centered around hybrid cloud computing. While some companies will go all-in on the public cloud, that’s not realistic for major enterprises with sprawling IT infrastructures. IBM’s hybrid cloud platform, powered by Red Hat software, provides a path for customers to modernize their infrastructure and take advantage of cloud computing while minimizing disruption and keeping an eye on costs. On top of software, IBM’s consulting arm provides guidance and help in navigating the move to a hybrid cloud architecture.
Like nearly every enterprise-focused technology company, IBM is seeing demand slow for certain types of products and services. In the second quarter, the company noted that projects from customers that are more discretionary in nature were increasingly being delayed. However, demand for large transformation projects with the potential to deliver meaningful cost savings remains strong. Even during an economic downturn, IBM can produce solid results by helping its customers boost efficiency.
IBM has stuck with its full-year guidance all year. On top of 3% to 5% revenue growth adjusted for currency, the company sees free cash flow coming in around $10.5 billion. That’s up more than $1 billion from 2022. With a market capitalization of about $133 billion, the stock trades for roughly 12.6 times free cash flow.
While IBM isn’t the fastest-growing tech company, it’s well-positioned to deliver solid results and free cash flow across a wide range of economic conditions.
Timothy Green has positions in AT&T and International Business Machines. The Motley Fool has positions in and recommends Apple. The Motley Fool recommends International Business Machines. The Motley Fool has a disclosure policy.