Early this year, IBM (NYSE:IBM) shareholders were enjoying a slow, but steady increase in its stock price -- and in investor confidence -- until a set of disappointing revelations snapped them back to reality.
Specifically, IBM released the numbers on a soft first quarter in which total revenue declined -- again -- and let the markets know that a few deals that had been expected to close earlier this year had instead been put on hold.
Thus, even though IBM's $18.2 billion in Q1 sales came in above analysts' consensus estimates, the fact that it was a 3% drop -- and marked the company's 20th straight quarter of revenue declines -- were what most pundits and investors focused on.
IBM's stock price was at $170.05 prior to its earnings announcement on April 18. By the close of the June 13 trading day, its shares were down 9% to $154.25.
Based on that dour news, how much risk will an investor buying IBM today? Not as much as you might think.
Taking it on the chin
Beyond the decline in total revenue, IBM's profit margins are taking a beating as it invests in growing its all-important strategic imperatives units. IBM ended the quarter with a total gross profit margin of 42.8%, well below last year's 46.5%.
Not surprisingly IBM's legacy hardware division was hit the hardest, though it makes up a smaller portion of total sales with each passing quarter. Last period's $1.4 billion in revenue from old-school solutions amounted to 16.8% less than it took in for Q1 2016. Given that the tech giant had $18.2 billion in revenue for the quarter, the hardware decline didn't make too much of a dent.
Last quarter's results left many in the investment community wondering if IBM's strategic imperatives initiative -- with its focus on the cloud, cognitive computing, data security, and the Internet of Things (IoT) -- will ever bring the company back to growth. With the already somewhat bearish sentiment rising, how risky is IBM?
Digging a little deeper
Despite the negative sentiment, there were plenty of things to like about IBM's first quarter, and some recent news also bodes well for the company. Strategic imperatives revenue grew 12% collectively year over year, led by an impressive 33% jump in cloud sales to $3.5 billion.
Exiting the quarter, IBM's annual cloud revenue run-rate of $14.6 billion put it in rarified company: Only Amazon.com's (NASDAQ:AMZN) AWS unit and Microsoft (NASDAQ:MSFT), with its bevy of software and service solutions, can boast similar cloud results. In Q1, AWS generated $3.66 billion in cloud sales, which is nearly a $15 billion annual run-rate.
Microsoft derives much of its cloud revenue from Cloud-as-a-Service (CaaS) offerings utilizing its Azure platform. As of last quarter, Microsoft was tracking at a $15.2 billion annual run-rate. IBM cloud is rolling, and better still, a whopping $8.6 billion of its cloud run-rate is CaaS revenue, a 59% year-over-year increase.
Hosting data in the cloud is nice, but offering solutions that give customers actionable results from a comprehensive analysis of the information is where the real opportunity lies. The analytics component of its cloud offerings was a key reason IBM was able to land its recent 10-year, $1.7 billion deal with Lloyd's Banking Group (NYSE: LYG).
IBM's strategic imperatives units now account for 43% of revenue -- a percentage that's rising each quarter -- and it shaved $860 million in selling, general, and administrative (SG&A) overhead in Q1. If not for an additional tax provision benefit of $654 million in 2016's first quarter, IBM's net income would have climbed to $2.4 billion, well above last year's $2 billion.
How risky is it?
By virtually every measure, IBM is one of the least expensive stocks in its sector. Its incredibly low valuation limits the downside risk, and its 3.9% dividend yield should help patient investors wait for the transformation to really take hold. Bottom line, IBM is one of the least risky stocks in tech.
Teresa Kersten is an employee of LinkedIn and is a member of The Motley Fool's board of directors. LinkedIn is owned by Microsoft. Tim Brugger has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Amazon. The Motley Fool has a disclosure policy.