IBM: Earnings Disappointment Creates Buying Opportunity
Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Shares of IBM (NYSE: IBM) fell more than 3.5% on Wednesday after the company reported earnings which disappointed investors. Although sales were lower than expected, IBM actually reported higher than expected earnings and the company even increased guidance.
What is more important from a long term point of view, IBM is taking the right direction in terms of growth drivers and product mix. This high quality company seeing temporary price weakness may very well be providing a nice entry point for long term investors with a strategic sense of opportunity.
More than 10 years ago IBM´s management made the right decision and decided to change the company´s focus from hardware to software and services. We can see in the chart from the company´s investor’s presentation that product mix has changed notoriously since that time, and that move produced a clear increase in operating margins over the years.
Hardware became a commoditized business in which profit margins are much lower due to competition and difficulties to create a differentiated product in the markets. While IBM has operating margins in the 20% area, companies like Hewlett-Packard (NYSE: HPQ) which is more dedicated to hardware, has operating margins below 7%. HP is increasing its exposure to services lately, and that´s probably the smart thing to do, but investors would have done much better if management had followed IBM steps back in 2000.
This focus on high margins business has provided the company with strong cash flows which IBM has deployed in growing dividends and shares buybacks. IBM has increased dividends for 16 consecutive years and has also implemented and active share buyback program. Warren Buffett has recently made a strong bet in this corporation and Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B) now owns more than 5% of IBM.
Buffett has been very explicit about how much he likes IBM when it comes to both its earnings prospects and its shares buyback program. When an undervalued company is purchasing its own stock investors have two strong tailwinds working for them: the business is generating growing cash flows and is also using them wisely by investing in its own shares at a convenient price.
Emerging markets are becoming an increasingly bigger part of overall revenue for IBM and as the higher growth regions become a bigger proportion of sales, the company should do well in terms of sales in the following years.
IBM has a goal of increasing earnings per share to at least $20 per share by 2015 from $14.4 in 2011. Considering its prospects for sales growth, margin expansion and shares count reduction; those plans look ambitious but achievable.
Short term price falls due to a disappointing quarter are sometimes a nice opportunity to acquire shares of high quality companies at discounted prices; this may very likely be the case for IBM from a long term perspective.
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