Although investors had been lowering their expectations for tech sector growth/performance this quarter, IBM (NYSE:IBM) still managed to spook the Street with soft revenue in both hardware and software. The long-term picture for IBM hasn't changed all that much, though it is likely that tech investors are going to be chewing their nails for at least another quarter. In the meantime, while IBM remains a well-run and comprehensive play on technology, the stock still isn't a great bargain.

Discount Brokers Comparison: Your one-stop shop for finding the perfect broker for your investments.

Some Weakness was Expected, but not This Much
It wasn't all that surprising that IBM's quarter was soft, as plenty of analysts thought that the hardware business was going to slow down. What was surprising, however, was the magnitude of the weakness.

Revenue fell 5% as reported, or about 2% on a constant currency basis. Services did best, with revenue basically flat on a constant-currency basis. Software was up 3% in constant currency (down 1% reported), but hardware dropped by 12% due to notable weaknesses in mainframes and storage products. Perhaps even worse for investor sentiment, management pointed to a significant slowdown in the month of September.

Although IBM's reported per-share earnings did meet expectations, the real story isn't quite so positive. Gross profit held up pretty well (up about one point on a GAAP basis) despite the revenue shortfall, due in part to the benefits of pruning less-profitable service business. Operating income disappointed, however, on higher SG&A expenses and fell about 7% on an adjusted basis. That IBM met numbers was a function of below-the-line items.

SEE: Understanding The Income Statement

Cycles and Timing Played a Role
Maybe IBM's underlying strength isn't as grim as the numbers in the third quarter would suggest. For starters, it sounds like some software business slipped into the fourth quarter as larger deals encountered some delays.

It's also worth noting that product launch cycles could have led hardware customers to postpone purchases. A new mainframe lineup came too late in the quarter to really help much, and the company likewise has new server and storage products on the way. With that in mind, a rebound in the fourth quarter shouldn't be out of the question so long as the North American macro picture doesn't get even worse from here.

Teasing Out the Trends
Even with the aforementioned potential impact from upcoming launches, some general trends may nevertheless be emerging from IBM's report. Weak server performance won't be good news for Dell (Nasdaq:DELL) or Hewlett-Packard (NYSE:HPQ). Likewise, I'll be curious to see what NetApp (Nasdaq:NTAP) has to say when it reports earnings; if it can't gain share from the likes of IBM, it's harder to support the growth thesis there.

IT services still seems like a solid growth opportunity for IBM, and it looks like the company continues to out-execute the likes of Infosys (Nasdaq:INFY) and HP. I will be curious to see if IBM continues to choose to improve margins at the cost of growth; it's almost certainly a better decision from the perspective of long-term value creation, but shareholders demand growth and management will have to find the point where the two demands balance out.

SEE: A Primer On Investing In The Tech Industry

The Bottom Line
IBM is often underrated as a savvy acquirer, and I doubt that the company is done with the wheeling and dealing. What I do wonder about, is whether the company has any particular desire to add to its hardware business; security appliances, for instance, would seem to be a logical target.

If IBM can continue to grow cash flow at a rate of 4 or 5%, these shares aren't a huge bargain today. A long-term growth rate of 5% would point to a fair value around $205 to $220, making names such as Oracle (Nasdaq:ORCL), Cisco (Nasdaq:CSCO) or Microsoft (Nasdaq:MSFT) look like better relative values. That said, IBM is a reliable and well-run company, and patient long-term investors could do worse than hold fairly-valued shares of this tech titan.

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

Related Articles
  1. Investing News

    Bank Stocks: Time to Buy or Avoid? (WFC, JPM, C)

    Bank stocks have been pounded. Is this the right time to buy or should they be avoided?
  2. Stock Analysis

    Why the Bullish Are Turning Bearish

    Banks are reducing their targets for the S&P 500 for 2016. Here's why.
  3. Stock Analysis

    How to Find Quality Stocks Amid the Wreckage

    Finding companies with good earnings and hitting on all cylinders in this environment, although possible, is not easy.
  4. Stock Analysis

    Analyzing Sirius XM's Return on Equity (ROE) (SIRI)

    Learn more about the Sirius XM's overall 2015 performance, return on equity performance and future predictions for the company's ROE in 2016 and beyond.
  5. Stock Analysis

    Will Virtusa Corporation's Stock Keep Chugging in 2016? (VRTU)

    Read a thorough review and analysis of Virtusa Corporation's stock looking to project how well the stock is likely to perform for investors in 2016.
  6. Stock Analysis

    Analyzing Porter's Five Forces on JPMorgan Chase (JPM)

    Examine the major money-center bank holding firm, JPMorgan Chase & Company, from the perspective of Porter's five forces model for industry analysis.
  7. Investing News

    What You Can Learn from Carl Icahn's Mistakes

    Carl Icahn has been a stellar performer in the investment world for decades, but following his lead these days could be dangerous.
  8. Stock Analysis

    Analyzing Dish Network's Return on Equity (ROE) (DISH, TWC)

    Analyze Dish Network's return on equity (ROE), understand why it has vacillated so greatly in recent years and learn what factors are influencing it.
  9. Fundamental Analysis

    5 Must-Have Metrics For Value Investors

    Focusing on certain fundamental metrics is the best way for value investors to cash in gains. Here are the most important metrics to know.
  10. Stock Analysis

    Analyzing Altria's Return on Equity (ROE) (MO)

    Learn about Altria Group's return on equity (ROE) and analyze net profit margin, asset turnover and financial leverage to determine what is causing its high ROE.
  1. When does a growth stock turn into a value opportunity?

    A growth stock turns into a value opportunity when it trades at a reasonable multiple of the company's earnings per share ... Read Full Answer >>
  2. What is the formula for calculating EBITDA?

    When analyzing financial fitness, corporate accountants and investors alike closely examine a company's financial statements ... Read Full Answer >>
  3. How do I calculate the P/E ratio of a company?

    The price-earnings ratio (P/E ratio) is a valuation measure that compares the level of stock prices to the level of corporate ... Read Full Answer >>
  4. How do you calculate return on equity (ROE)?

    Return on equity (ROE) is a ratio that provides investors insight into how efficiently a company (or more specifically, its ... Read Full Answer >>
  5. How do you calculate working capital?

    Working capital represents the difference between a firm’s current assets and current liabilities. The challenge can be determining ... Read Full Answer >>
  6. What is the formula for calculating the current ratio?

    The current ratio is a financial ratio that investors and analysts use to examine the liquidity of a company and its ability ... Read Full Answer >>
Trading Center