Why IBM Will Still Realize Its Future Profit Potential

Don't let it get away!

Keep track of the stocks that matter to you.

Help yourself with the Fool's FREE and easy new watchlist service today.

It's no secret that International Business Machines (NYSE: IBM  ) had a rough 2013. It was one of the worst-performing members of the Dow Jones Industrial Average. IBM's share price actually declined in 2013, during a year in which the Dow had its best year in the last 18. While disappointment over IBM's lackluster performance is understandable, long-term investors understand the merits of sticking with a high-quality company undergoing a difficult transition period. That's what appears to be the case with IBM, which still has ambitious expectations for itself in the years ahead.

"Growth markets" not living up to their name
The primary culprit for IBM's declining revenue in the most recent quarter was, ironically, what it terms its growth markets. In all, revenue in this segment declined 9%. Of particular concern was performance in China, which accounted for half of the company's revenue decline. Other emerging markets saw poor performance as well. Underperformance in this segment was the principal reason why IBM missed its revenue expectations by a full $1 billion.

Poor revenue growth has afflicted a slew of major technology companies, including IBM as well as Intel (NASDAQ: INTC  ) and Cisco (NASDAQ: CSCO  ) . The two, like IBM, are Dow components that had disappointing years from the perspective of underlying business performance. Intel's earnings per share are down 17% through the first nine months of the year, and management is only expecting flat results in 2014.

Meanwhile, Cisco's fiscal 2014 first-quarter earnings per share fell 5% versus the same period last year. Equally disturbing is the fact that Cisco expects current-quarter revenue to drop 4% versus the same quarter last year. Declines are expected in all of the company's major geographies.

Despite the widespread woes afflicting the large-cap technology space, IBM still maintains lofty expectations for profit growth going forward. While it may seem unlikely at the present time, the roadmap to IBM's earnings potential is still solid.

The formula for $20 EPS
Despite such notable weakness in the most recent quarter, IBM maintained both its full-year 2013 expectations as well as its long-term operational goals. Management still fully expects the company to earn $16.25 in operating earnings per share in 2013, and maintains its long-term goal of generating $20 in earnings per share by 2015. In light of the difficulties encountered this year, it's more than reasonable to wonder how exactly IBM will reach its targets.

First, IBM is in the process of a significant business shift toward higher-value, more profitable technologies. Specifically, no more will IBM be a hardware company; IBM is focusing intently on software, particularly among cloud-based offerings. IBM intends to generate half its profits from its Software operating division by 2015, and there's good reason for this. IBM increased its cloud-based revenue by 70% in the third quarter.

Next, IBM plans to aggressively repurchase its own shares with its prodigious cash flow, a long-held pattern that remains firmly intact. Despite IBM's revenue falling in the most recent quarter, its earnings per share actually increased 11%. This is due in large part to the company's share buyback program. IBM has spent $123 billion on share repurchases since 2000, which have reduced the company's share count by more than 35%. Between now and 2015, IBM plans to buy back an additional $50 billion in gross share repurchases.

In the end, trust in IBM management is the key question
At the end of the day, investors have to ask themselves whether they trust IBM management to hit the fairly ambitious goals laid out for the company. Judging by IBM's strategic initiatives, which include a major overhaul of its business focus, and tens of billions in planned share buybacks, there's a clear roadmap to reach $20 in adjusted EPS. IBM is a massively profitable business that seems to have hit a rough patch, but turning around a ship of IBM's size takes time. That's why investors would be well served to exercise patience.

Looking for top-line growth? The Motley Fool has you covered!
Opportunities to get wealthy from a single investment don't come around often, but they do exist, and our chief technology officer believes he's found one. In this free report, Jeremy Phillips shares the single company that he believes could transform not only your portfolio, but your entire life. To learn the identity of this stock for free and see why Jeremy is putting more than $100,000 of his own money into it, all you have to do is click here now.

Read/Post Comments (0) | Recommend This Article (0)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2794438, ~/Articles/ArticleHandler.aspx, 8/31/2015 6:52:37 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Bob Ciura

Bob Ciura, MBA, has written for The Motley Fool since 2012. I focus on energy, consumer goods, and technology. I look for growth at a reasonable price, with a particular fondness for market-beating dividend yields.

Today's Market

updated 2 days ago Sponsored by:
DOW 16,643.01 -11.76 -0.07%
S&P 500 1,988.87 1.21 0.06%
NASD 4,828.33 15.62 0.32%

Create My Watchlist

Go to My Watchlist

You don't seem to be following any stocks yet!

Better investing starts with a watchlist. Now you can create a personalized watchlist and get immediate access to the personalized information you need to make successful investing decisions.

Data delayed up to 5 minutes

Related Tickers

8/28/2015 4:00 PM
CSCO $26.00 Down -0.17 -0.65%
Cisco Systems CAPS Rating: ****
IBM $147.98 Down -0.56 -0.38%
International Busi… CAPS Rating: ****
INTC $28.42 Up +0.70 +2.53%
Intel CAPS Rating: ****