Why You Shouldn't Overreact to IBM's Earnings

IBM is struggling through its turnaround, but long-term investors will be rewarded for their patience.

Jan 25, 2014 at 3:00PM

Investors were hoping for signs of a quick turnaround when International Business Machines (NYSE:IBM) reported its fourth quarter and fiscal 2013 results. Unfortunately, IBM's progress is slower than the market would like. IBM's fourth quarter continued its trend from recent quarters of earnings growth against declining revenue.

From the market's perspective, cost cuts and share buybacks to engineer profit growth aren't good enough. While it's understandable to be disappointed over IBM's lackluster revenue performance in 2013, it should be given time to get its business back on track. IBM is a huge company, and turnarounds of this nature don't happen overnight. That's why Foolish investors would be wise to not overreact to IBM's disappointing earnings report.

IBM: A company in transition
The market was clearly displeased with IBM's report as well as its outlook, since the company's shares fell 3% after it released results. To be sure, there were enough disappointing items to complain about. Investors count on IBM for top-line growth due to its status as a world-class blue chip, but the company is stumbling in one key area.

For many years, IBM was known as a hardware company. Over the past few years, however, management decided to take the company in a new direction—and rightfully so. IBM deserves credit for seeing the writing on the wall in the technology world. Hardware is a shrinking business; going forward, growth will be most pronounced in software and services, particularly in cloud-based solutions.

IBM has transitioned itself to become much more of a technology consulting business, which has been a wise decision. This is what separates IBM from Hewlett-Packard (NYSE:HPQ), which has, for the most part, remained stuck in the hardware industry. All of HP's seven core operating segments saw revenue decline in the most recent year, led by its personal systems and printing group. Those segments produced a double-digit revenue decline.

Not surprisingly, hardware continued to be the sore-spot for IBM as it has for much of the past several quarters. In the fourth quarter, hardware revenue collapsed 26%. Fortunately, IBM's hardware business accounts for a relatively modest portion of its total revenue base. Nevertheless, the damage in the fourth quarter more than offset relatively decent results in the company's two larger segments, software and services. This is why total revenue fell 5% in 2013.

A $200 billion company doesn't turn on a dime
Large-cap technology giants simply can't turn their businesses around in a matter of a few quarters. Notice the changes being attempted at Oracle (NYSE:ORCL), which is in the middle of a similar shift to cloud-based solutions and services. Revenue from new software licenses and cloud software subscriptions in its most recent fiscal quarter ended November 30 was flat year over year. In addition, revenue from hardware systems products fell 3% in the same period. Total revenue inched up 2%, so it's clear that these types of transitions take time.

IBM is a $200 billion company by market capitalization, so its own turnaround will likely take more time. The market seemed disappointed with its fiscal 2014 projections, even though IBM expects to earn adjusted earnings of at least $18.00 per share. This would actually represent 10% earnings growth, and IBM remains fully committed to its promise to earn $20 per share in operating earnings by 2015.

IBM still generates a lot of free cash, which it will reinvest in the most promising growth areas going forward. Revenue growth may not materialize in the near term, but the company will still produce earnings growth from using some of its prodigious cash flow to buy back stock. In the meantime, investors can snatch up IBM for just 10 times forward earnings, with a 2% dividend yield as a nice bonus. That's why long-term investors would be wise to be patient with IBM.

All tech investors should know this company!
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 has no position in any stocks mentioned. The Motley Fool owns shares of International Business Machines and Oracle.. 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.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

So you can imagine how shocked I was to find out Warren Buffett recently told a select number of investors about the cutting-edge technology that's keeping him awake at night.

This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

That's how Buffett responded when asked about this emerging market that is already expected to be worth more than $2 trillion in the U.S. alone. Google has already put some of its best engineers behind the technology powering this trend. 

The amazing thing is, while Buffett may be nervous, the rest of us can invest in this new industry BEFORE the old money realizes what hit them.

KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

Yet according to one J.D. Power and Associates survey, only 1 in 5 Americans are even interested in this technology, much less ready to invest in it. Needless to say, you haven't missed your window of opportunity. 

Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

Don't let that happen again. This time, it should be your family telling you, "I can't believe you knew about and invested in that technology so early on."

That's why I hope you take just a few minutes to access the exclusive research our team of analysts has put together on this industry and the one stock positioned to capitalize on this major shift.

Click here to learn about this incredible technology before Buffett stops being scared and starts buying!

David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't 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.

©1995-2014 The Motley Fool. All rights reserved. | Privacy/Legal Information