Shares of IBM (NYSE:IBM) have fallen 13% over the past 12 months, woefully underperforming a 14% gain for the S&P 500. Revenue has declined for 11 consecutive quarters as it struggles to dump lower-margin businesses and transition to more profitable segments.

Source: Wikimedia Commons, Mark Ahsmann

Despite some glimmers of hope in cloud-related businesses, IBM could sink even further in 2015. Let's look at the top three reasons investors should beware of Big Blue.

1. Nonexistent growth
The main problem is a lack of top and bottom-line growth. Last quarter, revenue from continuing operations plunged 12% year-over-year as adjusted net income fell 11%. For the full year, revenue from continuing operations fell 6% to $92.8 billion with adjusted net income slipping 7% to $15.8 billion. Except for a meager gain in the global financing segment, IBM revenues were down across the board:


% of FY 2014 Revenue

YOY growth

Global Technology Services



Global Business Services






Systems and Technology



Global Financing






Source: IBM 2014 Annual Report

IBM attributed these declines to weak client spending, sluggish demand in the software sector, divestitures of several lower-margin businesses, and a strong dollar eating up its foreign revenue. Big middleware partnerships, such as those signed with Microsoft and Apple last year, might improve the situation, but IBM business services remain vulnerable to nimbler rivals such as Accenture.

2. IBM earnings game
Another fundamental problem is the way IBM inflated its earnings over the past few years. In 2010, then-CEO Sam Palmisano promised to double annual earnings per share from $10.01 to $20 by 2015. But to accomplish that, he accelerated stock buybacks and divested lower-margin businesses, a strategy that continued even after Ginni Rometty succeeded him in 2012.

Over the past 12 months, IBM bought back $12.97 billion in stock, exceeding its free cash flow of $12.69 billion during that period. Buying back stock reduces the number of outstanding shares and boosts earnings per share. Unfortunately, the money used for share repurchases could arguably have been allocated for acquisitions or other investments. To make matters worse, IBM funded these buybacks with debt, causing long-term debt to spike 43% over the past five years. Meanwhile, divesting lower-margin divisions temporarily boosted EPS as well but caused revenue growth to stall.

For 2015, Rometty backed away from the $20 promise with a more realistic projection of $15.75 to $16.50, which would represent only 1% to 6% year-over-year bottom line growth. However, Big Blue clearly has no plans to slow its buybacks or stop burning the furniture. It committed to a new $5 billion repurchase program last October, slashed 50,000 jobs in 2014, and could cut even more jobs in 2015.

3. All-in bet on the cloud
IBM believes expanding its higher-margin cloud businesses will offset its continuing year-over-year revenue declines.

To her credit, Rometty took major steps forward in expanding the cloud business by acquiring cloud computing company, SoftLayer Technologies, for $2 billion, investing $1.2 billion in a new business unit for its AI platform Watson, and signing "hybrid" cloud deals with large companies including Lufthansa, ABN Amro, and WPP. Hybrid cloud installations, which integrate cloud-based solutions with older on-site technologies, are popular among larger companies that are not ready or willing to upload all of their data to the cloud. Gartner believes half of all U.S. companies will use hybrid installations by 2017.

Those efforts have certainly paid off. In 2014, total cloud revenue rose 60% year-over-year to $7 billion with cloud delivered as a service revenue rising 75% to $3 billion. Unfortunately, the cloud still represented a small slice of its $92.8 billion top line. This business is unlikely to grow fast enough to offset declines in services, software, and hardware.

The verdict
Contrarian investors might consider IBM to be a good, beaten up, blue chip stock that could recover over the next few years. However, the company needs to patch up some big holes in its hull before it can sail properly again.

With a forward P/E of 10, there is certainly a limit to how much deeper Big Blue can sink. Value-seeking income investors can consider picking up some shares for its 2.7% yield, but the stock is unlikely to bounce back anytime soon.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.