For IBM Corp., Shortsightedness Rules the Day

After posting outstanding earnings, analysts instead choose to focus on the negatives.

Tim Brugger
Tim Brugger
Jul 23, 2014 at 11:27AM
Technology and Telecom

When IBM (NYSE:IBM) announced earnings on July 17, its stock was trading at $192.49 a share, or what amounted to a slightly less than 3% gain year-to-date. After demolishing year-over-year earnings, and demonstrating outstanding growth in the key areas that CEO Ginni Rometty has a laser-like focus on, IBM shares dropped to $190.85 by the close of trading this past Monday. What?

Oh, there are reasons for the ho-hum response by the market following IBM's earnings release.  Just ask the legion of analysts who are lamenting Big Blue's results. However, the reasons for so much negativity, particularly directed toward an industry leader in the midst of a significant transition, speaks more to analysts' and investor's unwillingness, or inability, to look beyond next week. This is good news for long-term investors in search of an inexpensive addition to their portfolio.

The "bad" news
IBM is hardly alone when it comes to bellwether tech giants getting no respect in the midst of a game-changing reorganization. Just ask Microsoft (NASDAQ:MSFT) CEO Satya Nadella. Like IBM, Microsoft is in the process of reinventing itself, and despite posting more than respectable results for its recently announced fiscal Q4 2014, it's receiving only a lukewarm response from investors. But Microsoft's tepid reception would be a breath of fresh air to IBM, who can't seem to garner even the slightest of good tidings.

Despite some perceptions, there's a lot to like about IBM's recent quarter. IBM's earnings, a measure that usually carries a great deal of weight in the minds of investors, were off the charts. In Q2, IBM generated earnings-per-share, or EPS, of $4.12, a 42% jump from the same period last year.

Recent lay-offs and some belt-tightening resulted in a 15% decline in expenses for the quarter, and IBM went on to announce non-generally accepted accounting principle, or GAAP,  earnings for the year are expected to come in around $18 a share. Rometty has said many times her objective is to generate $20 a share in earnings by 2015 and if this year finishes as expected, IBM would appear to be on pace.

But where IBM really excelled was where it mattered, in its "strategic growth initiatives." Cloud, big data, and mobile revenue results are what investors should be focused on, similar to its longtime competitor Microsoft and its emphasis on "mobile-first, cloud-first." For IBM, cloud revenue rose over 50% in Q2, and is now tracking at nearly $3 billion annually. That still trails Microsoft's more than $4.4 billion annual cloud-related revenues, but the two old foes are squaring off for a new, 21st century battle. Just like old times.

Now add a 100% improvement in mobile revenues and increases in both business analytics -- big data -- and security-related sales, and you're left with what was a sound quarter for IBM.

What's not to love?
The biggest problem analysts had with IBM's quarter was its flat, to slightly down, total revenues. At $24.4 billion, IBM's sales dropped 1%, adjusting for the divestiture of a customer service unit. The culprit was IBM's hardware business. In a slowly stabilizing PC market, hardware sales declined over 11% compared to last year.

Other "issues?" The growth in earnings per share, or EPS, it could be argued, was the result of IBM's share buyback plan, as well as its aggressive cost cutting initiatives. Both efforts supposedly just masked a lack of revenue growth by IBM.

Related Articles

Final Foolish thoughts
IBM's effort to streamline operations and better align its workforce with cloud technologies, big data, and mobile isn't some kind of smokescreen, they were much-needed steps as Rometty changes the way IBM does business. Microsoft is in the same boat, which is why Nadella announced its largest job cuts ever: 18,000 by year's end.

If you're focused on IBM's total revenues, like many analysts are, it's not a suitable investment right now. Nor is Microsoft, for that matter. But if you're looking for long-term growth at a bargain, IBM has a forward price-earnings ratio of a mere 9.80 -- not to mention a decent dividend yield of 2.27%. For those that are more concerned with next year than next week, IBM is an absolute steal.