25% of International Business Machines Should Scare Investors!

While IBM's fundamental performance in the second quarter may seem improved, its continued weakness in hardware and especially servers leaves a major hole in its investment outlook.

Jul 21, 2014 at 2:30PM
Ibm

International Business Machines (NYSE:IBM) exceeded low expectations with its second-quarter earnings as the company continues to shift from an on-premises IT focus to the cloud. However, significant weakness in 25% of its business continues to have a fundamentally crippling effect, especially when peers Hewlett-Packard (NYSE:HPQ) and Cisco (NASDAQ:CSCO) are thriving in these businesses. Nonetheless, should this weakness in 25% of IBM be reason enough for investors to avoid the company?

Which 25%?
IBM's considerable weakness in hardware is no secret to investors, as it's a problem that has been well documented for more than a year. The rise of cloud computing has seemingly replaced the need for certain hardware, and IBM has made investments that have cannibalized much of its hardware business.

In recent quarters, IBM has seen year-over-year losses in excess of 20% in its hardware segment, which unfortunately accounts for 15% of its total business. During its second quarter report, however, hardware actually saw some improvement, as its 11% sales decline was viewed as a positive.

Therefore, with expectations already low for hardware, investors don't seem too concerned with its lack of performance. However, the company's continued problems with servers is a major problem as it's this business that helps connect IBM's other products and services to its enterprise clientele.

During the second quarter, servers saw a whopping 28% sales decline over last year. This segment alone accounts for 10% of the company's total revenue. Combined with hardware, IBM has a major problem: 25% of its business seeing double-digit losses and major market share losses.

Servers are the lingering problem
While 10% of total revenue may not seem like a big deal, for IBM it's over $9 billion worth of revenue and a segment that creates recurring business that is highly profitable. The problem for IBM is that top technology peers like HP and Cisco have penetrated this market with success and are in the process of creating a strong footprint with enterprise clients. With these clients electing to use Cisco and HP's servers, Big Blue is put at risk of losing business in other key segments like storage, chips, and even mainframe sales.

With that said, IBM's second quarter results in servers gives investors an initial glimpse at what should be a continued trend in the server space. During the first quarter, IBM's server business saw a 25% decline in revenue to $2 billion, which consequently cost it a 600 basis point decline in overall market share to 19.1%.

While IBM hurts, others thrive
HP's 2% decline in server revenue was equal to the overall industry's performance. The company finished the first quarter with $2.9 billion in revenue from servers, or more than 10% of its total revenue. While not a growth industry, HP's success and leading market share of 26.5% has undoubtedly helped the company to thrive in other key industries such as enterprise PCs, which saw a 12% boost during the last quarter.

Clearly, HP's success in servers has helped its overall business. However, the real beneficiary of strong server performance has been Cisco, a company that has taken the market by storm. Cisco is relatively new to this space, and server sales account for only 5% of its total revenue.

However, its UCS server offers improved performance with both the deployment of applications and scalability versus older servers. As a result, its revenue soared 37% during the last quarter to $617 million, gaining it 170 basis points of market share to 5.7%.

While servers are still a small piece of Cisco's fundamental pie, it has helped drive the performance of data center switches, which is conveniently another weakness of IBM. Granted, neither HP or Cisco have announced second-quarter earnings, but if the first quarter's performance and IBM's second quarter server sales are any indication, both HP and Cisco are sure to gain even more market share while growing stronger in key businesses like enterprise PCs and switches that consequently hurt IBM.

Foolish thoughts
With all things considered, it's interesting to see the correlation between IBM's weakness in servers and how its peers are stealing market share and outperforming it in other key businesses. IBM is a company with a fundamental weakness that has almost grown accepted on Wall Street. As it continues to suffer in key industries, the company's fundamental outlook will remain challenged. Meanwhile, Cisco and HP are both trading near 52-week highs. As they become more dominant in this key industry, investors should feel confident in their long-term prospects looking ahead.

Top dividend stocks for the next decade
The smartest investors know that dividend stocks simply crush their non-dividend paying counterparts over the long term. That's beyond dispute. They also know that a well-constructed dividend portfolio creates wealth steadily, while still allowing you to sleep like a baby. Knowing how valuable such a portfolio might be, our top analysts put together a report on a group of high-yielding stocks that should be in any income investor's portfolio. To see our free report on these stocks, just click here now.

Brian Nichols has no position in any stocks mentioned. The Motley Fool recommends Cisco Systems. The Motley Fool owns shares of 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