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Thursday's Dow Winner: IBM

By Alex Dumortier, CFA - Jan 23, 2014 at 7:14PM

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IBM's sale of its low-end server business cheers investors.

Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.

Was it the fault of the Chinese economy or the U.S. economy? Either way, U.S. stocks finished in the red on Thursday, with the S&P 500 down by 0.9%. The narrower Dow Jones Industrial Average (^DJI -0.27%) fared slightly worse, losing 1.1%. Only seven Dow components were winners on the day, one of them being International Business Machines (IBM 0.47%).

On Tuesday, I highlighted a report that IBM was in talks to sell its low-end server business to Lenovo, and things have apparently moved swiftly along since then. Big Blue announced on Wednesday that it had signed a definitive sales agreement to sell the x86 server business to the Chinese PC manufacturer for approximately $2.3 billion.

That news has lifted shareholders' spirits after a disappointing fourth-quarter earnings report on Tuesday that saw IBM's revenue drop 5% -- its seventh consecutive quarterly sales decline. IBM had already shopped the server business last year, but concluding the sale is a measure of its determination to hopscotch onto higher-margin/higher-growth activities... which brings us to the heart of the matter. As the Financial Times' respected Lex column pointed out today:

IBM's previous divestitures look so smart now because they were followed by smart bets on the next big thing. It remains to be seen whether the company can repeat that crucial part of the trick. IBM sells well, but what it invests in is much more important.

So, what is the "next big thing" this time around? Steve Mills, Group Executive of IBM Software and Systems provides a clue with his statement that, "This divestiture allows IBM to focus on system and software innovations that bring new kinds of value to strategic areas of our business, such as cognitive computing, Big Data and cloud."

Big data and cloud (computing) are clearly growth opportunities, and IBM is now ramping up its offer in these areas after having been slow to recognize their potential. Last Friday, the company announced it is committing $1.2 billion to "significantly expand its cloud footprint," with plans to open 15 new data centers worldwide this year.

"Cognitive computing" refers to IBM's newly formed Watson unit. (Watson, an artificial language application, aims to provide answers to difficult questions phrased in natural language.) This looks more speculative in terms of its revenue and profit potential, although the company reportedly has high hopes for its future.

Will these be enough to power IBM through another iteration in its creative destruction/ transformation? Perhaps. What is certain, however, is that at 10.2 times next 12 months' earnings-per-share estimate, the market is setting a relatively low bar for IBM to step over. As I've mentioned a couple times previously, the current share price is not much above (<10%) Warren Buffett's cost basis on one of Berskhire's top equity positions.

Fool contributor Alex Dumortier, CFA has no position in any stocks mentioned; you can follow him on Twitter @longrunreturns. 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.

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Stocks Mentioned

Dow Jones Industrial Average (Price Return) Stock Quote
Dow Jones Industrial Average (Price Return)
^DJI
$33,888.87 (-0.27%) $-91.45
International Business Machines Corporation Stock Quote
International Business Machines Corporation
IBM
$138.44 (0.47%) $0.65

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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