Investing is a game of perpetual worry, so there's nothing especially novel about the concerns over the health of IT spending in 2012. The benefit of this to IBM (NYSE:IBM) is that the company is so diverse, so long as there's some spending it will be OK. Moreover, while that pesky "peak margins" argument/worry seems to be popping up again, the company's momentum in software seems encouraging for near-term results.

Investopedia Markets: Explore the best one-stop source for financial news, quotes and insights.

Good Enough Results for Q4
IBM didn't blow out the doors for the fourth quarter, but they did well enough. Reported revenue rose about 2% and it would seem like most of the revenue shortfall vis a vis Wall Street estimates was a byproduct of foreign currency - something notoriously difficult to model. Software led the growth (up 9%), while service revenue was OK (up 3%) and certainly better than hardware (down 8%).

With more revenue coming from higher-margin businesses, it's not hard to see how IBM wringed more profit leverage out of results. Gross profit improved almost by a full point, while reported pre-tax profits rose nearly 5% on a 70bp improvement in margins.

Peak Margins?
A good stand-by for bearish analysts and investors who can't otherwise elucidate a clear negative thesis is the "peak margin" story. Simply put, this is the idea that a company/industry/economy has squeezed out all the fat that is there to be squeezed and that there's just no way to keep up the leverage. (For related reading, see Operating Leverage Captures Relationships.)

With IBM, that concern is often focused on services. I can sort of see where the skeptics are coming from. Compared to consulting and IT service names like Accenture (NYSE:ACN), CommVault (Nasdaq:CVLT) or Computer Sciences (NYSE:CSC) IBM does indeed have very good margins. However, the company will be hard-pressed to match the Indian rivals like Infosys (Nasdaq:INFY) that can take advantage of lower outsourced labor costs.

I'm generally skeptical of arguments that run along the lines of "things can't get better, because they've never been better than this." After all, what of those predictions of yesteryear that New York City couldn't possibly grow more (or the streets would be buried in horse dung) or that automobiles were doomed to fail (because the human body couldn't withstand speeds above what a horse could produce)?

Hardware a Concern, But Not a Worry
IBM did report a notable weakness in hardware and that has some potential implications for the tech space. Servers seemed weak, and that's not great news for Hewlett-Packard (NYSE:HPQ) or Dell (Nadsaq:DELL); especially if IBM's results are being goosed by migration away from HP hardware in the wake of Oracle (Nasdaq:ORCL) dropping support for certain HP products.

Storage was likewise soft, due in part to disruptions tied to hard drive availability. Arguably this is a bigger risk to NetApp (Nasdaq:NTAP) than EMC (NYSE:EMC), but it suggests that the lower-end markets could be soft.

Last and not least is the mainframe business. Results definitely weren't strong (System z sales were down 31%), but this is probably more of a pause between cycles than anything more troubling.

The Bottom Line
On admittedly conservative estimates (a 10-year forward free cash flow growth CAGR of about 5.5%), IBM looks only slightly undervalued. With other tech hardware names trading at significantly larger discounts to fair value, it's hard to argue for putting new money into IBM. (For related reading, see Compound Annual Growth Rate: What You Should Know.)

As for whether to keep holding IBM, that depends on the original expectations that went with the purchase. Investors who bought back in the "IBM is doomed" days have a nice gain to show for their contrarian play, but IBM really isn't a turnaround story anymore. On the other hand, investors who bought IBM as part of a high-quality, lower-volatility portfolio don't need to be in any rush to change things up.

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.

Related Articles
  1. Stock Analysis

    Net Neutrality: Pros and Cons

    The fight over net neutrality has become an amazing spectacle. But at its core, it's yet another skirmish in cable television's war to remain relevant.
  2. Entrepreneurship

    Top 10 Side Jobs You Could Start Now

    Ways to make extra cash in your spare time.
  3. Personal Finance

    A Day in the Life of an Equity Research Analyst

    What does an equity research analyst do on an everyday basis?
  4. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
  5. Mutual Funds & ETFs

    ETF Analysis: ProShares Large Cap Core Plus

    Learn information about the ProShares Large Cap Core Plus ETF, and explore detailed analysis of its characteristics, suitability and recommendations.
  6. Mutual Funds & ETFs

    ETF Analysis: iShares Core Growth Allocation

    Find out about the iShares Core Growth Allocation Fund, and learn detailed information about its characteristics, suitability and recommendations.
  7. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI USA Minimum Volatility

    Learn about the iShares MSCI USA Minimum Volatility exchange-traded fund, which invests in low-volatility equities traded on the U.S. stock market.
  8. Stock Analysis

    Should You Follow Millionaires into This Sector?

    Millionaire investors—and those who follow them—should take another look at the current economic situation before making any more investment decisions.
  9. Professionals

    What to do During a Market Correction

    The market has what? Here's what you should consider rather than panicking.
  10. Mutual Funds & ETFs

    ETF Analysis: Vanguard Mid-Cap Value

    Take an in-depth look at the Vanguard Mid-Cap Value ETF, one of the largest and most popular mid-cap funds in the U.S. equity space.
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Hard-To-Sell Asset

    An asset that is extremely difficult to dispose of either due ...
  3. Sucker Yield

    When an investor has essentially risked all of his capital for ...
  4. PT (Perseroan Terbatas)

    An acronym for Perseroan Terbatas, which is Limited Liability ...
  5. Ltd. (Limited)

    An abbreviation of "limited," Ltd. is a suffix that ...
  6. BHD (Berhad)

    The suffix Bhd. is an abbreviation of a Malay word "berhad," ...
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>

You May Also Like

Trading Center

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!