IBM Earnings: Will Big Blue's Growth Strategy Finally Work?

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On Thursday, IBM (IBM 0.06%) will release its quarterly report, and investors remain cautious in their assessments of the tech giant's future promise. Even though IBM is following the same general trends toward cloud computing and data analysis as rivals Cisco Systems (CSCO 0.44%) and Oracle (ORCL -0.97%), IBM's execution thus far hasn't inspired a huge amount of confidence or a substantial move upward in IBM's share price.

For decades, IBM relied on hardware products to drive its growth, with its creation of the PC leading to a long period of dominance of the technology world. Seeing the writing on the wall, IBM shifted away from hardware as it started to become more of a commodity business, instead emphasizing higher-margin services and software products. Yet IBM's latest transition hasn't been as effective in helping it compete against Oracle, Cisco, and its numerous other competitors. Let's take an early look at what's been happening with IBM over the past quarter and what we're likely to see in its report.

Stats on IBM

Source: Yahoo! Finance.

Will IBM earnings really soar?
Analysts have had mixed views on IBM earnings in recent months, cutting about 2% from their second-quarter estimates but raising full-year 2014 projections marginally. The stock has remained mired in its slump, though, falling 3% since early April.

IBM's first-quarter results continued a troubling trend for the tech giant. Revenue fell even more than investors had expected, with overall declines of 4% reflecting a huge 20% plunge in sales in China. The sales declines were consistent with IBM's strategy of de-emphasizing its lower-margin hardware business for better profit opportunities in software and services, and the fact that earnings per share has managed to stay steady and even grow as sales fall confirms the potential success of that strategy in the long run.

Source: IBM.

But many investors remain unconvinced by IBM's long-term strategic vision. In May, IBM held its annual investor meeting, at which CEO Ginni Rometty said that the entire tech industry is in what she called a reordering phase, with the net impact of changing the entire complexion of technology over the next decade. Despite Rometty's assurance that high-end data systems and storage could help lead IBM forward, flat earnings in its hardware segment could hold the company back. IBM's chief financial officer sees substantial earnings-per-share gains coming from its switch to higher-margin services and from its ongoing share buybacks, but the end of certain tax credits will weigh on results. Moreover, while Cisco Systems has seen the same trouble keeping revenue up, Oracle has managed to grow both sales and earnings even as it pursues many of the same opportunities as IBM.

Part of the problem is that IBM's approach to research and development seems inconsistent at times. For instance, earlier this month, Big Blue said that it would expand its R&D spending on design of more efficient chips, seemingly going back on its move away from hardware. With such great success in seeing its cloud-computing revenue grow, it's unclear why IBM is still trying to compete in the cutthroat semiconductor industry, where profit prospects seem more uncertain and less promising than in the services area where Cisco and Oracle seem to be focusing more of their new efforts.

Still, the cloud isn't an automatic road to profits for IBM. Price competition has made its way throughout the industry, and IBM cut its prices on cloud storage by more than half last month in order to better compete against low-price alternatives. For IBM, offering basic cloud services isn't as much an end in itself as it is a gateway toward more extensive projects with enterprise customers, and IBM hopes that driving more high-margin business will offset any pressure from cloud price wars.

In the IBM earnings report, watch to see how Big Blue positions itself for its last critical year in its drive toward $20 earnings per share for 2015. As shareholders grow increasingly impatient for results, IBM needs to deliver concrete guidance on how it will implement its big-picture strategies in the future.

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