International Business Machines Corp. (NYSE:IBM)‘ earnings, for the most part, were a pretty huge disappointment. Analysts were anticipating higher rates of growth from the company, but the company was unable to pull off the expected growth rates as it was unable to close some deals in the quarter.
Is the decline warranted?
The sudden share drop was driven by short-term fear due to the awful results management was able to post for the first quarter. Investors buy stocks in anticipation of future earnings. When companies report lower than expected guidance, or data that may potentially point towards deterioration of fundamentals, investors dump the stock.
IBM’s business wasn’t able to generate any substantial growth from its growth markets. The BRIC segment dropped 1% year-over-year, and it certainly doesn’t help that the dollar is rallying against a basket of currencies as this is lowering reported income.
International Business Machines Corp. (NYSE:IBM) grew earnings by around 8% (non- GAAP); the earnings came in at around $3 per share for the quarter. Net income declined 1% year-over-year, with revenue a bigger disappointment by declining 5% year-over-year. The decline in both top and bottom line performance indicated fundamental weaknesses in the macro environment along with some management incompetence.
A company can blame a miss on revenue due to macroeconomic changes, or weakness in the structural, business environment. A company that misses earnings could blame changes in the business model, unfavorable changes that resulted in lower recognition of revenue, along with declining efficiencies. This past quarter, International Business Machines Corp. (NYSE:IBM) did all of the above. Weakening economy, bad management, changes in accounting policies etc.
The whole thing blew up all at once, with the bottom line weakness coming from declining profit margins due to lower pricing power in the system and technology division. In fact, systems and technology revenue declined 16%, which is why the company had such a difficult quarter.
On the bright side, International Business Machines Corp. (NYSE:IBM) reported advances in the smarter planet, business analytics and cloud. International Business Machines Corp. (NYSE:IBM) reported revenue growth of 7% in business analytics, 25% growth in the smarter planet segment, along with blow out revenue growth of 70% from the cloud. The cloud could become a $210 billion industry according to AT&T. IBM’s growth depends heavily on the cloud.
Information is pertinent to other companies
IBM’s solid quarter in the cloud (up 70%) should keep investors upbeat on companies solely focused on the cloud, such as VMware, Inc. (NYSE:VMW). VMware, Inc. (NYSE:VMW) reported year-over-year revenue growth of 13%. It was able to sustain revenue growth, but margins were slightly compressed, with net income declining $0.04 year-over-year as VMware, Inc. (NYSE:VMW)’s management team is more focused on top-line rather than bottom line growth.
VMware, Inc. (NYSE:VMW) is investing aggressively in acquisitions and research and development in order to remain a toe-to-toe competitor with big blue (IBM). With IBM reliant on cloud for growth, it is likely that it will deploy additional resources in order to capture a larger share of the market. VMware, Inc. (NYSE:VMW), in anticipation, is willing to endure declining margins in order to keep up with its well-capitalized competitor.
IBM reported a 2% decline in profit margins from the systems and technology division. With total revenue from the segment declining 17%, this has multiple implications. First, it means that competition is heating up which is forcing IBM to cut prices. IBM isn’t the only mainframe computer/networking solutions provider in the world. Smaller companies can live with lower profit margins, and IBM is just a brand, the function of networked computing can be found anywhere.
After all, a mainframe/super computer is just a collection of computers working together to process code. Mainframes are built by combining a group of computers and synchronizing the computer into a single function.
Intel Corporation (NASDAQ:INTC), in its recent quarterly earnings announcement, said that it was able to grow revenue from its data center processing business by 7.5% year-over-year. The decline in IBM’s profit margin may imply that Intel is charging higher prices for its mainframe processors as Intel Corporation (NASDAQ:INTC) processors are used in mainframe computing. Intel processors are generally more power efficient, and dollar-per-dollar offer the best performance.
Intel Corporation (NASDAQ:INTC) should continue to grow in an environment of further virtualization. Virtualization is when a consumer uses a computer in a way that involves remote accessing (accessing programs and data from an online server). The cloud is just an alternative way of storing and using data. The core back-bone of the cloud are Intel processor-based servers. Not to mention, servers rely heavily on faster data-transfer speeds which is dependent on the speed of the hard drive.
Intel Corporation (NASDAQ:INTC)’s investment in solid-state drives, along with the economy of scale Intel has when compared to other hard drive manufacturers, should keep investors optimistic about Intel’s future in cloud computing. Intel Corporation (NASDAQ:INTC) is well-positioned on the data center side; Intel’s problem has been the weak mobile strategy, along with declining desktop shipments.
Intel Corporation (NASDAQ:INTC) provided weak guidance; investors are anticipating low single-digit growth over the next five years. When it comes down to risk- to-reward, Intel is falling off the cliff. Low-growth tech stocks should never be a part of an investor’s investment portfolio; technology comes with the added risk of uncertainty. I would never accept low-yields with additional risk.
Conclusion
IBM stands by its guidance, while declining revenue and net income should be a reasonable area of concern. Management remains relatively unfazed by the recent miss. Assuming IBM is able to post solid performances in the remaining quarters this fiscal year, and declines in its hardware division subsides, investors may gravitate back to the stock. Management hopes to sustain earnings per share growth through share repurchases and cost-cutting along with organic revenue growth.
Going forward, IBM could be a value investment opportunity as management’s guidance wasn’t altered much. The stock’s 12.50% decline could be a potential entry-point, assuming management wasn’t fibbing when it said earnings will continue to grow 10% year-over-year for the next five years. Assuming IBM can sustain growth, the stock’s pull-back will most likely be temporary, and investors hoping for a better entry-point can find one at its current price.
The article Is This Stock’s Recent Dip an Opportunity? originally appeared on Fool.com is written by Alexander Cho.
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