Why Did IBM Miss the 2013 Dow Rally?

A rising tide lifts all boats -- except those that are full of holes. The Dow Jones Industrial Average (DJINDICES: ^DJI  ) has soared more than 13% higher in 2013, government shutdowns and all. Meanwhile, IBM (NYSE: IBM  ) missed the rally altogether and lost 5% of its value instead (or 3% with dividends included). What's going on with Big Blue?

^DJI Chart

^DJI data by YCharts.

IBM hasn't been its usual dependable self lately. The company reported lower sales year over year in each of the last five quarters, lower operating cash flows in the last four, and sinking GAAP earnings in three of the last four reports. Big Blue even missed Wall Street's earnings targets in the April report, which is as rare as a Turkish movie with a happy ending.

So IBM has disappointed investors in 2013, but the numbers rarely tell the whole story.

That first-quarter miss rested on weak software and services orders from the sequestering U.S. government and a Chinese government in flux. Above all else, IBM's management saw the Chinese changes coming at the federal level but forgot to scale back its targets on the regional and provincial scale.

Moreover, IBM is under new management this year. Longtime CEO Sam Palmisano stepped down and handed the reins to Ginni Rometty in January 2012. As you might expect, the new CEO started shifting the company's priorities.

IBM was shooting for a top-to-bottom balance between software, hardware, and support services under Palmisano's steady hand. This model applied to all of IBM's many target markets, and Palmisano successfully pursued many of them.

In Rometty's reign, the company is shifting its focus to the big data macro trend. The company is slowly abandoning many former target markets where competition is rampant and margins are shrinking. This shift explains some of IBM's weak revenue trends, but it should be a temporary weakness that eventually fuels a dramatic return to strong growth. We just have to wait for Rometty's long-term strategy to mature and pay off.

Of course, that's easier said than done when investors are faced with bottom-line trends like these:

IBM Net Income TTM Chart

IBM Net Income TTM data by YCharts.

This is where the advice on the cover of The Hitchhiker's Guide to the Galaxy comes in handy: "Don't Panic." Feel free to sell or stay away from IBM if you're not buying Ginni Rometty's big data strategy, but don't let the slumping share price scare you away otherwise.

The upside to low prices is that patient investors get a tremendous discount. IBM shares are trading at a historically low price-to-earnings ratio of just 10.1. Buy when there's blood in the streets, if you believe in the long-term thesis.

IBM Chart

IBM data by YCharts.

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9/29/2016 4:35 PM
^DJI $18143.45 Down -195.79 -1.07%
IBM $158.11 Down -0.18 -0.11%
IBM CAPS Rating: ****