IBM's Earnings: 3 Important Takeaways

Yesterday, two of the technology heavyweights on the Dow Jones Industrial Average (^DJI -0.98%) faced off by releasing their third quarter earnings: Intel (INTC 1.77%) and IBM (IBM -8.25%).

Although neither company dazzled analysts (read about Intel's performance) and IBM's weak performance has weighed heavily on the index, the Dow is nevertheless in the midst of an earnings-season rally. It closed higher yesterday by triple digits. And while it began today in the red, it's seemingly in the midst of an ascent, down by only five points, or 0.04%, at the time of writing.

Examining IBM's earnings
As you can see below, while IBM's earnings per share grew on a year-over-year basis, it nevertheless came up short of consensus estimates on both the top and bottom lines. Revenue for the quarter was $24.75 billion, compared with an estimate of $25.36 billion, and EPS came in at $3.33 against an expected $3.61.

Source: The Wall Street Journal.

Given these results, it should be no surprise that shares in the services giant are trading sharply lower today, currently down more than 5%.

In no particular order, here are three important takeaways from IBM's third-quarter earnings release.

1. Emerging-market growth
Over the last few years, IBM has invested heavily in the so-called "growth markets" around the world. While its overall results were underwhelming, as evidenced by the top- and bottom-line misses, this strategy appears to be paying off, though not as quickly as the company had likely hoped.

Adjusted for the currency headwinds discussed below, revenue from growth markets improved by 4%, and if you include only the four BRIC countries -- Brazil, Russia, India, and China -- that figures ratchets up to 11%. According to IBM's chief financial officer, "This quarter, 35 of the growth market countries grew at a double-digit rate, reflecting ongoing broad-based strength." By comparison, revenue from the Americas region fell on a comparable basis by 3%.

2. Currency headwinds
As we've seen with other companies -- namely, Coca-Cola (KO 0.31%) and Johnson & Johnson (JNJ -1.15%) -- the volatile and unpredictable nature of the currency markets confused IBM's results. To give you just two examples, while revenue from the Americas was negatively affected by three percentage points, revenue from the growth markets was up by the same degree before adjusting for currency changes. All told, currency headwinds hurt IBM's revenue by nearly $1 billion in the third quarter.

The specific catalyst was the fact that the U.S. dollar gained 13% on the euro during the third quarter. However, the more general catalyst is action on the part of virtually every country's central bank as monetary policymakers around the world competitively ease their currencies in an effort to spur economic growth. Some have even referred to the trend as a "currency war."

3. Improving margins
Finally, on a more positive note, IBM's gross margin increased by a respectable 90 basis points. Since taking over as the chief executive officer earlier this year, Ginni Rometty has shifted the company's focus away from highly commoditized services and toward higher-profit software and services like data analytics and cloud computing. According to statements made by the company on its conference call: "Our margin expansion was driven by our productivity initiatives, improving business mix, and the overall currency dynamics."

Foolish bottom line
Despite having a relatively dismal quarter in terms of revenue and earnings, IBM remains an industry powerhouse. It's presumably for this reason that none other than Warren Buffett's Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B) owned nearly 70 million shares in the company at the end of June. To learn about another of Buffett's powerhouse holdings, click here to access our free report on "The Only Big Bank Built to Last."