The Dow Jones Industrial Average (INDEX: ^DJI) was up 119 points, to 16,395, at 1:30 p.m. EST after IBM (NYSE: IBM), the blue-chip index's second largest component, gained 3.5% despite a disappointing earnings report. The S&P 500 (INDEX: ^GSPC) was up 10 points to 1,867.
At first glance, IBM reported fourth-quarter earnings that beat analyst expectations, but the company made some interesting accounting moves to make that happen. IBM's adjusted earnings per share rose to $6.13, above analyst expectations of $5.99. Big Blue appears to be managing earnings to show better than expected results. Adjusted earnings included a $0.25 per-share benefit related to acquisition accounting, as well as a $0.15 per-share benefit related to the company's retirement accounting. If you exclude those and just use generally accepted accounting principles earnings, IBM missed analyst expectations and reported earnings of just $5.73 a share. On top of all of this are large tax benefits that are included in both GAAP and non-GAAP earnings. The tax benefits give the company an effective tax rate of 11.2%; exclude those and the earnings were even worse than they appear.
Revenue fell 5.5% to $27.7 billion, below analyst expectations of a fall to $28.3 billion. Hardware revenue dropped 25% year over year to $4.26 billion, the ninth-straight quarterly drop, and business services revenue dropped 3.6% to $9.92 billion. Forty percent of the company's hardware business is in China, which has proven particularly challenging as the government there clamps down on spending and Chinese companies worry over U.S. spying following the information leaks from former National Security Agency contractor Edward Snowden.
IBM is reportedly in talks to sell its low-margin server business to Lenovo. The company previously sold its ThinkPad laptop division to Lenovo in 2005. Big Blue also announced that it would take a $1 billion "workforce rebalancing" charge this year, which analysts expect to involve layoffs of between 10,000 and 15,000 employees.
As an article in today's Wall Street Journal noted, IBM has been spending large and growing amounts of cash on share buybacks, but has not been increasing investments in its actual business. By hedge fund manager Jim Chanos' calculations, IBM's buybacks have only returned 6.5%, while investments in its business return 18%. Chanos commented that, "Either they expect higher returns from the market, or lower returns in their business, or some combination of both. Given their questionable track record in timing the market, this may be a cause for concern."
Concern may be warranted, as IBM disappointed with its guidance for 2014 that called for adjusted earnings of $18 per share. Investors had already priced in some lowered guidance as IBM competitor Intel (INTC +5.51%) reported disappointing earnings last week and lowered its guidance. Also affecting IBM today is the outlook for competitor Advanced Micro Devices (AMD +7.80%), which fell and then clawed back into the green after forecasting a 16% drop in first-quarter sales. The weak results and lower guidance from IBM and its competitors resulted in lower price targets for IBM from Barclays ($173) and J.P. Morgan ($175).
IBM is not the only tech company that appears to be buying back its stock high and getting a bad return on its investment. The WSJ article also noted three other companies, while I have previously highlighted Apple as a poster boy for this.
