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IBM Stock Looks More Dangerous Than It Appears Ahead of Earnings

Will Healy

International Business Machines (NYSE:IBM) reports its second-quarter earnings on July 17 after the bell. This will be the company’s first earnings report since completing the purchase of Red Hat. For this reason, many investors may look for clues as to whether this acquisition can help resume growth and reverse the revenue declines that have led to an overall decrease in IBM stock over the last few years.

IBM Stock Looks More Dangerous Than It Appears Ahead of Earnings

Although earnings reports tend to tell what happened in the past, investors need to go into this report focused on the future.

Watch Revenues, Guidance

Consensus IBM earnings estimates for the quarter stand at $3.07 per share. If this number holds, it will come in one penny per share less than the second quarter of 2018, when the company earned $3.08 per share. They also forecast revenues of $19.16 billion, 4.2% less than the $20 billion earned in the same quarter last year.

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Although the Armonk, New York-based IT giant usually beats earnings estimates, the company fell short on revenue in the first quarter. Revenue growth has become an ongoing challenge as none of its divisions registered revenue growth in the previous report. Hence, analysts will probably watch this report carefully on revenue guidance.

With revenue disappointing, earnings growth also becomes a struggle. IBM may avoid a drop in profits. However, analysts only forecast an earnings increase of 0.7% for the year.

IBM’s Position in the Market Remains Uncertain

This makes the forward price-to-earnings (P/E) ratio of around ten much less appealing. Also, its annual dividend yields almost 4.6% and has increased for 19 consecutive years. However, with the payout ratio now at over 66%, one has to wonder how long the dividend increases can continue for IBM stock if its negligible profit growth does not improve.

Also, the company recently completed its acquisition of Red Hat. However, only time will tell whether that will help make the venerable IT giant successful in today’s tech world. IBM has existed since 1911. It also managed to remain relevant long after its original technology became obsolete.

However, the likes of Amazon (NASDAQ:AMZN), Apple (NASDAQ:AAPL), Facebook (NASDAQ:FB) and Microsoft (NASDAQ:MSFT) have now passed the company by to a significant degree. With this challenge, one has to wonder whether IBM can successfully reinvent itself again.

IBM Stock Is ‘Speculative’

This makes IBM stock something you would not normally associate with a large, profitable company — speculative. It is a different kind of speculative than a penny stock hoping to make it back. In this case, IBM bulls hope the company can do well enough to maintain itself and its annual dividend increases.

If Red Hat integration and other initiatives can resume significant growth rates for the company, IBM stock is very cheap at these levels. However, if anemic growth forces the company to end its 19-year streak of dividend increases, stockholders will probably face years of pain.

The Bottom Line on IBM

Going into earnings, IBM stock investors need to watch guidance. Given its history, I think IBM will beat earnings. However, revenue declines and a high dividend payout ratio should cause concern.

Hopefully for IBM stock bulls, revenue guidance will offer some hope, both for the integration of Red Hat into the company and for the resumption of revenue growth.

To be sure, the low price-to-earnings ratio and the high dividend yield in a company with a history of payout increases could attract bargain hunters. However, these supposed benefits hide serious dangers. If the company fails to reverse revenue declines, a cut in payouts remains a real possibility.

Hence, I think investors should avoid this stock going into earnings. Moreover, unless and until revenue looks poised to improve, I would treat IBM as speculative.

As of this writing, Will Healy did not hold a position in any of the aforementioned stocks. You can follow Will on Twitter at @HealyWriting.

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