Key Points
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IBM pre-announced some of its second-quarter results and missed expectations on the top and bottom lines.
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Customers have been shifting money towards memory chips and servers instead.
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This feels like a temporary problem, and the stock looks attractively valued as a result.
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Last week, International Business Machines (NYSE: IBM), better known as IBM, pre-announced its second-quarter revenue and earnings. To put it mildly, it was not well received by investors.
On the day of the earnings pre-announcement, IBM shares fell by 25%. That’s its worst single-day performance since Black Monday in 1987.
To be fair, IBM’s announcement was certainly bad news from a short-term perspective. But it doesn’t dramatically change my long-term thesis with the stock, and I’m planning to use this opportunity to add to my position. Here’s exactly what IBM revealed from its second quarter numbers, what we don’t know yet, and why I’m buying more shares on the dip.
The numbers were ugly
I won’t sugar-coat it. IBM’s preliminary third-quarter numbers were pretty bad. The company said revenue would come in at $17.2 billion, versus nearly $17.9 billion that analysts had expected. On the bottom line, adjusted EPS of $2.93 also fell short of the $3.02 consensus estimate.
Now. Those numbers were bad, but not enough to warrant a 25% decline on their own. The real story is how CEO Arvind Krishna explained it. He said that in the last couple of weeks of June, IBM’s enterprise customers quickly redirected spending toward memory chips, servers, and other hardware in anticipation of price increases and supply constraints. This caused budgets for IBM’s software and consulting to drop sharply. IBM’s infrastructure, consulting, and software revenue all came in weaker than expected.
On one hand, this frames IBM’s products and services as somewhat discretionary. But on the other hand, there’s a big difference between falling demand and “customers are delaying their spending with us.” Demand didn’t vanish — it simply got reprioritized due to the memory chip shortage.
Krishna said that IBM didn’t do a great job in anticipating the shift, and he’s right. But IBM’s disappointing software and consulting revenue should come back in later quarters as the supply and demand dynamics in memory and other hardware start to come back to equilibrium.
Why I’m buying more
To be sure, there’s a lot we don’t know. IBM didn’t pre-release its entire earnings report, just a few key numbers and an explanation. We don’t yet know IBM’s bookings, which are indicative of future revenue. Optimism about IBM’s stock price has been fueled more by the growing AI business book than by current realized revenue.
After the decline, IBM’s stock is trading for about 17 times earnings, and it has a 3.2% dividend yield that is well-covered by the company’s cash flow. The AI tailwinds that have caused bookings to grow exponentially in recent quarters haven’t changed — only spending priorities have, and temporarily. IBM’s early leadership in quantum computing and the future potential of that side of the business are still intact.
In a nutshell, everything I liked about IBM from the perspective of a 5+ year time horizon still applies. And now I can buy shares at a discount.
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Matt Frankel, CFP® has positions in International Business Machines. The Motley Fool has positions in and recommends International Business Machines. The Motley Fool has a disclosure policy.
