Short answer: Yes, it does matter, but not nearly as much as some people are making it out to be. In fact, while the recent quarter was the 6th consecutive of falling revenues, IBM's (NYSE:IBM) revenue problems aren't quite as severe as some people are making them out to be. When Warren Buffett announced his Berkshire Hathaway (BRK.A, BRK.B) made a purchase of IBM stock large enough to make it one of his largest common stock holdings, commentators claimed IBM hadn't had any revenue growth for ten years. While not lineal, and not very substantial, the general trend has been moving up, actually.
While not ideal, revenues certainly aren't taking a nosedive, which would be much worse. During this same discussion with Buffett it was even claimed that the EPS numbers going up during this period was nothing more than financial sleight of hand, due in large part to having fewer shares outstanding, and therefore illusory. Buffett's response, which I agree with, was, "There's nothing wrong with fewer shares outstanding." With fewer outstanding shares, investors' share of the pie increasing is indeed not an illusion created by accounting, but something very real. Over the last 10 years, IBM's EPS have increased over 300% and the share price has doubled. Importantly, dividends have also risen nearly 600%, another sign of financial soundness.
So how long can they keep this up? For quite some time actually. One important thing generally left out of bearish discussions pertaining to IBM is that there is another variable at play besides for share repurchases which are driving earnings up: net income. In fact, it has played more of a role than share buybacks have. Viewing the last 10 years of EPS growth in conjunction with shares outstanding and net income growth shows about 60-65% of it is due to increased net income.
Net Income(in billions)
The main catalyst for this is margin improvement, which is being driven by their increased involvement in the high-margin software area. Going from 35 to 45% of pre-tax income over the past 10 years, it has room to increase and you can expect it to moving forward. IBM expects it to be 50% in 2015. Gross margins for software are near 90%, much higher than what services, hardware or financing has to offer them.
To make room for software's growth, hardware's share of pre-tax income has been shrinking substantially, down from 35% in 2000 to 14% in 2012. It still is a large enough piece of the company to have a substantial impact though. Looking at their most recent quarter you'll see it was hardware which was the major drag on them in regards to revenue. In particular China, which accounted for 1.2 of the 1.6 points of constant currency decline in revenues for the quarter according to statements from the Q3 earnings call.
As hardware continues to become more and more obsolete within the company's strategy, IBM might be able to enter into some low to mid single-digit top-line growth. It should be viewed as a vote of confidence in IBM management's ability that they have been proactive in dealing with this, getting ahead of the curve by pruning its hardware presence whereas those who stayed the course are suffering now.
Thanks to their actions profit margin growth has been on a consistent trend up over the last 10 years. Even a 1% increase makes a large difference, as with $100 billion in revenues it gives an extra $1 billion in net income.
With the billions in buybacks and dividends handed out to shareholders over the last decade, and this strategy continuing to play a part in generating returns for shareholders moving forward, more focus should be diverted towards free-cash flows remaining healthy rather than worrying so much over top-line growth. 2012 left them with $18.2 billion in free-cash flows, a near $12 billion increase over where they were in 2000. And what they've done since then is pretty remarkable.
$237 billion in cash has been used since then through 2012:
- $123 billion on share repurchases
- $55 billion on capital expenditures
- $33 billion on acquisitions
- $26 billion on dividends
Besides for being extremely dedicated to shareholders, there is another reason IBM is able to produce their "roadmaps" for future financial performance. It's a pretty predictable business. They exceeded the goal for EPS stated in their 2010 roadmap, and still maintain they'll reach their 2015 goal of $20 EPS, which at current share prices would leave a very low p/e. There really isn't something which has come to light recently of a substantial nature that changes the course I felt IBM was on when its stock was trading much higher. Coupled with the sticky nature of their business items such as their $141 billion in services backlog are very attractive, yet the stock languishes.
It's funny, Buffett explicitly said this is what he wished would happen to their stock price when he made his purchase, and now that it has been realized people are questioning if he will sell. A better question would be asking if he will be taking advantage of the sale being offered by Graham's old friend, "Mr. Market," and purchasing more shares.