Despite IBM's Struggles, It Can Still Reach Its Ambitious Profit Forecast

International Business Machines (NYSE: IBM  ) is a company in transition. Formerly known as a leader in the technology hardware space, IBM is trying desperately to shift focus into software and services. Fortunately, several years ago, management saw the writing on the wall -- which is that hardware is not the future of technology.

The unfortunate part is that the turnaround is taking longer than management likely anticipated. That's because companies the size of IBM can't simply turn on a dime. It's a $188 billion company by market capitalization, after all. A meaningful turnaround for a company this large will take time.

The same thing is happening to Hewlett-Packard Company (NYSE: HPQ  ) . It's also trying to break away from hardware and enter newer technologies, but progress has been slow.

IBM management has pledged to produce $20 per share in operating profits by the end of next year. That would represent a fairly big jump from its profits last year. Since its refocusing is taking longer than expected, you might think IBM is setting itself up for disappointment. But there's actually reason to believe that IBM can hit its forecast. Here's how it will do it.

Can earnings grow with poor revenue growth?
In short, yes. IBM's revenue growth in recent periods is unimpressive. Revenue fell 5% last year, then declined another 4% in the first quarter of 2014. That hardly sounds like a recipe for producing strong earnings growth. Indeed, IBM's target of $20 in operating EPS represents 22% growth from the $16.28 per share generated last year.

Many of IBM's problems have to do with hardware. Revenue in the systems and technology group fell 23% last quarter. Meanwhile, other non-hardware-related segments are performing relatively well. IBM is growing nicely in middleware. Revenue from WebSphere grew 12%, while revenue from Tivoli software increased 7%.

IBM is doing even greater things in cloud solutions. Cloud revenue jumped 50% last quarter. And, for cloud delivered as a service, the company reached an annual run rate of $2.3 billion, which doubled year over year.

Likewise, HP's core business continues to be centered on hardware, which is really holding it back. It's busily building out its other software and services businesses, but its large printers segment continues to drag it down. HP's revenue fell 7% in 2013, and the company followed this performance with a 1% revenue decline in the fiscal 2014 first quarter.

On the second-quarter conference call, HP Chief Executive Meg Whitman assured analysts that sustained revenue growth is her top priority. To accomplish this, she pointed to several initiatives in new areas that will fuel the future.

Not surprisingly, HP is gearing significant investment toward the cloud, just like its technology peers. For example, HP launched a new portfolio of products and services called Helion, which allows for seamless and secure integration of private, public, and managed cloud information at the enterprise level.

In similar fashion, IBM is shifting its hardware business toward higher-value opportunities. In particular, it's growing its systems product portfolio, more specifically in power and storage, in an attempt to build on its strength in big data and mainframes.

The formula for $20 EPS
In the meantime, IBM already has a highly profitable business that throws off a lot of cash. This is then funneled back to boost earnings growth through huge share repurchases. IBM has repurchased $108 billion of its own shares since 2000. This includes $13.9 billion in share buybacks just last year.

These share buybacks are going a long way in generating earnings growth, even while revenue lags. And, when combined with cost cuts, IBM maintains its forecast to earn $20 in operating EPS by the end of next year. The forecast for the current year is $18 in EPS, so management can instill a lot of confidence in investors by reaching its near-term goal. If everything goes according to plan, IBM can definitely reach its ambitious profit expectations.

Leaked: This coming device has every company salivating
The best investors consistently reap gigantic profits by recognizing true potential earlier and more accurately than anyone else. Let me cut right to the chase. There is a product in development that will revolutionize not just how we buy goods, but potentially how we interact with the companies we love on a daily basis. Analysts are already licking their chops at the sales potential. In order to outsmart Wall Street and realize multi-bagger returns, you will need The Motley Fool's new free report on the dream team responsible for this game-changing blockbuster. 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: 3018277, ~/Articles/ArticleHandler.aspx, 9/1/2015 8:31:07 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 11 hours ago Sponsored by:
DOW 16,528.03 -114.98 -0.69%
S&P 500 1,972.18 -16.69 -0.84%
NASD 4,776.51 -51.82 -1.07%

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

8/31/2015 4:02 PM
IBM $147.89 Down -0.09 -0.06%
International Busi… CAPS Rating: ****
HPQ $28.06 Up +0.03 +0.11%
Hewlett-Packard Co… CAPS Rating: ***