IBM's Software Growth Sped Up and Its Stock Barely Moved. I'd Start Buying.

Before International Business Machines (NYSE:IBM) posted third-quarter results on Oct. 21, I set a bar for buying the stock. I wanted software revenue growth back in the high single digits and recurring revenue rising close to 10%.

The software half of that test came through. IBM's software segment reported 9% year-over-year revenue growth at constant currency (a measure that strips out exchange-rate moves). In the second quarter, it grew just 5%.

But shares barely budged on Thursday, the day after the report, closing up less than 1% after falling as much as 4% during the session. IBM stock closed at $252.11, which puts it about 23% under the $329.23 record close it set on June 2.

In September, I wrote that I expected IBM stock to be higher in five years but still wouldn't buy it. What I was waiting for was software growth that picked back up. I think this quarter delivered it.

Image source: Getty Images.

Software is growing faster again

Software matters more to IBM's profits than any other piece of the business. The segment made up around 46% of third-quarter revenue but about 65% of the company's segment profit, so its swing this year counts for a lot.

Software's constant-currency growth was 8% in the first quarter of 2026. It cooled to 5% in the second quarter before jumping to 9% in the third -- its fastest rate of the year. Transaction processing, the software linked largely to IBM's mainframes, did most of the swinging. It dropped 9% at constant currency in the second quarter and climbed 10% in the third. Better still, software's segment profit rose 15% year over year to around $2.7 billion, and its margin widened to 35% from 33%.

"Software revenue growth accelerated four points sequentially to 9% this quarter, including over four points of organic growth," chief financial officer Jim Kavanaugh said on IBM's Oct. 21 earnings call.

Granted, some of the jump is timing. Kavanaugh said around a quarter of the acceleration came from big deals that slipped out of the second quarter and closed in the third. The other three-quarters, he said, came from new business.

I think this makes the second quarter look like the exception, not the start of a slide.

Does the unchanged revenue forecast matter?

IBM still expects full-year revenue to climb 4% to 5% at constant currency, the same range it set in July. But it now expects 2026 free cash flow to rise by over $1 billion from last year's $14.7 billion. In July, it expected a gain of around $1 billion.

Kavanaugh said IBM ties its profit and cash flow plans to a 4% base case for revenue, and it kept that approach this quarter. Under that plan, IBM now expects software to grow about 7% to 8% this year, with 7% as the base case.

I don't think the unchanged revenue forecast takes much away from the software turn. Software carries most of IBM's profit, so a faster software business can raise cash flow even when total revenue growth stays in the same range. And third-quarter free cash flow climbed around 28% year over year to $3.0 billion.

Recurring revenue is the half of my test that hasn't shown up yet. IBM's annual recurring revenue, a yearly run-rate measure of its recurring software business, grew 8% to $24.9 billion, still below 10%. But Kavanaugh said he expects that growth to near double digits in the fourth quarter.

IBM stock looks reasonably priced again

IBM's market value of around $235 billion is about 15 times free cash flow, based on what IBM now expects for this year. Shares also sell for about 19 times earnings using analysts' 2027 estimates. At the June record, the stock cost closer to 25 times earnings.

Thursday's flat finish might have been more about the run-up into the report. Shares rose around 8% over the three trading days before it, so part of the good news was arguably priced in already.

The risk is that recurring revenue might stay stuck near 8%, and that software's pace could slow when the slipped deals are behind it. But IBM pays a quarterly dividend of $1.69 a share, which yields around 2.7% at today's price, as investors wait to see what the fourth quarter holds.

In the end, software did what I needed it to do, and the stock price hasn't followed. I'd start buying IBM stock here, maybe in a few smaller purchases, and add more if recurring revenue gets closer to 10% in the fourth quarter.

Daniel Sparks and his clients do not have positions in any of the stocks mentioned. The Motley Fool has positions in and recommends International Business Machines. The Motley Fool has a disclosure policy.