Leading up to its earnings report on October 17th (Monday), International Business Machines (IBM) was hyped to a new 52-week high of 190.16 per share. Given that the major indices have been bouncing back and forth within the same range for almost three months, this shows that investors have been looking for some real strength in the company's positioning relative to most other large-caps. This article will look at the recently released Q3 report and give some insight on whether or not IBM has justified its recent outperformance.
EPS beats, but on weak revenue
Non-GAAP diluted EPS for the company was $3.19 in Q3 2011; beating analyst estimates by a hefty margin and growing 15% from Q3 2010. While this is generally perceived as good news, we've seen many earnings beats in recent years that have been largely ignored by the markets. A more forward-looking view can be found by analyzing revenue trends instead of earnings trends, since earnings are affected by outside variables that can make it difficult to see what's really going on.
While IBM's year-on-year EPS may suggest that the company has experienced somewhere near 15% sales growth; doing some digging can reveal that most of the EPS growth has come from margin improvements. Overall operating margin for the company has reached a new high of 46.5%; which shows that the company is becoming very efficient at delivering its products while minimizing costs. Does this represent organic growth in IBM's sales though?
IBM's overall revenue has only increased 8% year-on-year (and a measly 3% adjusting for currency). Considering that companies have been increasing IT-spending rapidly since 2010, this makes the numbers look even less impressive. Competitors like Oracle (ORCL) have been growing at a much faster rate.
Emerging markets and cloud computing
“Growth markets delivered outstanding revenue performance across software, hardware, and services and contributed to the company's expanded margins. We also achieved strong results in Smarter Planet, business analytics and cloud."
--Sam Palmisano, IBM Q3 2011 earnings report
Although I have been largely negative thus far on the company due to the somewhat sluggish revenue growth, there are some bright spots one can find in the report. Emerging markets (or "growth markets" as IBM calls them) have increased year-on-year revenue by nearly 20% as of Q3 2011. Despite the concerns of a slowdown in emerging markets like China; companies have still been spending heavily on their IT systems.
Cloud computing has been another stellar performer for big blue. According to the report, sales revenue from cloud products and services in 2011 has already doubled the cumulative revenue from the entire fiscal year of 2010. This is an amazing statistic, and if IBM can keep up a fraction of that kind of market expansion in the future it could be enough to offset the relatively flat revenue trends in other divisions. This is a big "if" though, as other companies are stepping up to the cloud revolution too.
Is IBM stock attractively valued?
IBM is trading at a P/E multiple of over 15 after reaching a record in operating margin. On top of a very small dividend of about 1.6% and mildly impressive revenue growth of around 8% the stock is beginning to look quite expensive. On the other hand; IBM has a strong presence in emerging markets. Even the United States has shown decent organic sales growth in the last year. Then there's the bright future of cloud computing, which IBM will have a large stake in.
Nonetheless, for the near term, IBM has become quite expensive. Wall Street has already hyped the company's potential in emerging markets and the cloud computing revolution, which has already boosted the shares significantly. Given the presence of much cheaper stocks on the market nowadays, many with both higher revenue growth and dividends than big blue, I couldn't recommend adding into a position of IBM until shares drop a bit more.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
