You're Crazy to Be Selling IBM

For as complex as IBM's (NYSE: IBM  ) business can be, the simple truth is that this stock was too cheap before investors began selling it this morning.

Let's get right to the numbers. Revenue was down 7% from last year to $23.6 billion and failed to meet the Street's consensus of $23.86 billion. But there were bright spots in the revenue picture: Software sales were down just 2.6%, and technology services revenue was down 4.4% year over year.

The numbers improve further down the income statement. Across-the-board cost cuts helped Big Blue improve gross margin by 180 basis points. That, plus a reduced share count, led to higher earnings per share: IBM booked $2.40 in per-share income for the third-quarter, an 18% improvement over last year's third quarter.

I'll understand if you're still skeptical. Bottom-line growth without corresponding top-line growth never lasts. Big Blue is going to have to boost revenue again at some point.

But it's hard not to like where IBM is headed. Management raised full-year earnings guidance to at least $9.85 per share, up from $9.70 after last quarter's report. CEO Sam Palmisano credited higher-value deals for his company's more bullish outlook.

"We continued to invest for growth in areas where clients see potential for value creation including Smarter Planet solutions, cloud computing and advanced business analytics," Palmisano said in a press release.

He and his team need to make good on their strategy. Until they do, 12 times earnings is going to seem reasonable for a company of Big Blue's size and history. Growth may not last, and fierce competitors are getting fiercer: Dell (Nasdaq: DELL  ) bid $30 per share to acquire Perot Systems (NYSE: PER  ) , giving it more services clout. And new cloud-based mail software will put IBM in direct conflict with Google (Nasdaq: GOOG  ) , as well as Microsoft (Nasdaq: MSFT  ) .

But at its current multiple -- again, 12 times IBM's revised full-year earnings projection -- the stock seems priced more for the risks Big Blue faces than the rewards it could yield from prudent investments in massive-growth opportunities.

Some will call that cautious. I call it crazy. What do you think? Sound off using the comments box below.

Dell and Microsoft are Inside Value picks. Google is a Rule Breakers recommendation. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Tim Beyers had stock and options positions Google and a stock position in IBM at the time of publication. Check out Tim's portfolio holdings and Foolish writings, or connect with him on Twitter as @milehighfool. The Motley Fool is also on Twitter as @TheMotleyFool. The Fool's disclosure policy can go big, but never gets blue.


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  • Report this Comment On October 16, 2009, at 2:34 PM, au90cu10 wrote:

    I wholeheartedly agree, that IBM is undervalued ...

    soooo, what else is new . I have trumpeted for

    years, that IBM is probably THE most misunderstood

    stock on the exchange , even by the "analysts".

    For decades, many analysts seem to have been

    waiting for IBM to fade away.

    I believe, that over the years, many professionals

    have exited IBM, only be to greatly surprised and

    missed out on great opportunities, now they are

    just sour grapes.

    Probably no other company, EVER, has continuously

    reinvented itself and it's markets like IBM has ...

    In short, yes, it's crazy to sell IBM ... anyone

    who has held for 30+ years has 16 times the #

    of shares purchased(much more with div reinvest)

    and that means that they are making something

    like 25-30% on their original investment just

    from the divvy .... later .... garce

  • Report this Comment On October 18, 2009, at 11:55 PM, drteter wrote:

    I would agree with this article's thesis...I think that IBM is very much hated by the analysts because they keep waiting for the company's growth to stop because it is "too big to grow"....but yet it continues to grow earnings and will continue to for a long time. Fair value for a company like this is much much higher than its current price. Will the price ever fully catch up with its intrinsic value? Only time will tell...but value investors everywhere should be betting on it

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