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IBM Woes and Stock Decline May Be Only Just Starting

Jon C. Ogg

International Business Machines Corp. (IBM) is a very important stock to the broad stock market. It is worth some $210 billion, and it is the largest stock of the Dow Jones Industrial Average (DJIA) by far. The problem, on top of an analyst downgrade Tuesday, is that IBM's growth is nonexistent. Management is allowing morale to suffer, and employee departures appear to be creating knowledge and talent vacuums in regional offices that drive sales. A short seller has become very aggressive here, and the stock price trouble for IBM could be just starting.

Credit Suisse already had a cautious Neutral rating on IBM, but now its research department downgraded the stock rating to a very unattractive Underperform rating. The prior $200 price target was taken down to $175 in the call. To make matters worse, this IBM downgrade was not just a traditional analyst downgrade due to valuation. Credit Suisse had this as part of an Ideas Engine Series feature. The downgrade shows that future organic growth will be challenging. Kulbinder Garcha, the Credit Suisse analyst who made this downgrade, said:

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We are also concerned by deteriorating free cash flow and a less effective mix up to software revenue. We see relative and absolute downside to $175, even if the company achieves the 2015 $20 earnings per share roadmap target.

We recently had a chance to speak to the team running the Ranger Equity Bear ETF (HDGE). These portfolio managers have IBM as the largest short position in the entire ETF, effectively double the traditional weighting. Their concern is the internal metrics, poor earnings quality and core market erosion.

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If Credit Suisse and the Ranger Equity Bear team are correct, IBM has more downside to come. Indexarb.com showed that IBM's weighting in the DJIA was 9.6% of the DJIA as of Monday. That is significant because it is the number one DJIA stock by weighting. IBM's weighting among the 30 DJIA stocks is literally larger than the bottom eight DJIA stocks combined, and it is nearly three-times the weighting of a traditional average weighting in the DJIA.

IBM may screen out as a cheap stock to value investors on the surface, but that is just not the case after you dig through the numbers and consider the internal metrics hurting Big Blue's business. This $20 earnings per share goal by 2015 will give IBM's current price a value of less than 10 times forward earnings estimates, but that earnings growth is due to share buybacks and endless cost cutting. Analysts see a drop of 2% in sales for Big Blue in 2013, followed by only 2% sales growth expected in 2014.

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Prior to the short seller screen, we showed that IBM's earnings cheer was overlooking that it simply has no real growth. In fact, its latest round of layoffs made us think that Milton from "Office Space" was running the show there. We even are disappointed with IBM's dividend rate, and that was after it was raised.

IBM was at $196 or so when we highlighted the short selling ETF interview. Shares were down 2.3% at $191.01 in late-Tuesday morning trading, against a 52-week trading range of $184.78 to $215.90. Be advised that this $175 price target is roughly $20 less than the prior street-low price target.

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