Why IBM Will Still Realize Its Future Profit Potential

Despite significant weakness this year, IBM's goal of $20 earnings per share by 2015 is still within reach. Here's why.

Jan 14, 2014 at 7:00PM

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.

Bob Ciura owns shares of Intel. The Motley Fool recommends Cisco Systems and Intel. The Motley Fool owns shares of Intel and International Business Machines. 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.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich" rated The Motley Fool as the #1 place online to get smarter about investing.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of fool.com.

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to www.fool.com/beginners, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. It's also featured on several dozen radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at www.fool.com/podcasts.

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.

Compare Brokers