Why IBM Is Dragging on the Dow Jones Today

IBM is down after missing earnings expectations.

Dan Dzombak
Dan Dzombak
Apr 17, 2014 at 1:30PM
Markets

IBM (NYSE:IBM) is weighing on the Dow Jones Industrial Average (DJINDICES:^DJI) today after reporting disappointing earnings. As of 1:20 p.m. EDT the Dow was flat at at 16,434. The S&P 500 (SNPINDEX:^GSPC) was up a mere four points to 1,866.

With its relatively high stock price, IBM is one of the Dow's heaviest-weighted components, so its 3.1% decline today is having an outsize effect on the index.

IBM reported earnings yesterday evening that disappointed investors. Earnings per share excluding one-time items fell 15% year over year to $2.54, right in line with analyst expectations. One-time items include an $870 million restructuring charge related to layoffs; with those expenses included, EPS came to $2.29.

For the fifth quarter in a row, however, IBM reported revenue that missed expectations. In the first quarter of 2014 revenue was down 4% year over year to $22.5 billion, missing analyst expectations of $22.9 billion. Sales were especially weak in China, where revenue declined 20%. IBM continues to be hurt by declines in the server business, where revenue fell 23% to $2.4 billion. IBM is taking steps to exit the server business. IBM plans to sell its x86 server business to Lenovo for $2.3 billion, provided the deal is approved by Chinese and U.S. regulators. You may recall that Lenovo is the company that purchased IBM's personal-computer and ThinkPad division in 2005. IBM and Lenovo's relationship appears to follow the classic disruptor model where an incumbent exits low-margin businesses to focus on higher-margin opportunities, continually giving up market share to challengers.

IBM maintained its EPS guidance of $18 for 2015 and $20 for 2015. The company is investing more in the high-margin growth areas of cloud computing, security, and mobile. Its most high-profile effort is cloud computing, where the company plans to invest $1 billion in an effort to grow its earnings.

Is IBM still a Buffett Pick?
Warren Buffett historically tends to buy businesses with strong moats at 10 times pre-tax earnings. Case in point, Warren first bought IBM in 2011 at 9.7 times pre-tax earnings. This came as a shock to many, as Buffett has a famous aversion to tech stocks.

Over the past 12 months, IBM had pre-tax earnings of $18.9 billion.

IBM Pre-Tax Income (TTM) Chart

IBM Pre-Tax Income (TTM) data by YCharts.

With a market cap of $204.5 billion, IBM's stock currently trades at 10.8 times pre-tax earnings, so if history is any guide, the stock may have to fall further before we can expect to see Buffett purchasing shares again.