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What to Look for When IBM Reports Its Q3 Numbers

James Brumley

This year has been rewarding for shareholders of business technology titans like Microsoft (NASDAQ:MSFT) and Nvidia (NASDAQ:NVDA). Microsoft stock is up 36% year-to-date, largely driven by its growing cloud computing lineup, while Nvidia has gained 33% on its deeper penetration of the AI hardware market. However, a number of big tech names, including International Business Machines (NYSE:IBM), have been left out of the party. IBM stock is down 4% since the end of last year.

Investors are concerned that IBM is still a relic that has no place on the modern technology landscape. What if, however, the doubts that have been suppressing the IBM stock price are mostly unmerited? That may be the conclusion more than a handful of traders reach after ol’ Big Blue reports its third quarter numbers. The company is slated to unveil its results on Oct. 16 before the opening bell rings.

IBM Earnings Preview

As of the latest check, analysts on average expected IBM to report Q3 revenue of $19.1 billion and earnings of $3.39 per share.

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IBM reported EPS of $3.26 on sales of $19.15 billion in the same quarter a year earlier. But it’s also worth noting that IBM’s Q1 and Q2 EPS surpassed analysts’ consensus estimates. Additionally, IBM has logged year-over-year revenue growth every quarter since Q4 of last year.

With the one-year anniversary of the turnaround in sight, however, this is where things start to get challenging for IBM stock. But if the company’s results are strong,  the performance of IBM stock could nevertheless improve.

Over the Hump

Most investors understand that IBM simply wasn’t ready for the advent of cloud computing, cybersecurity, mobile devices and artificial intelligence, all of which are ultimately interdependent. Relying too much on the strength of its traditional server and related systems business and failing to innovate much until recent years, IBM saw its top-line growth deteriorate in 2012.

But there are no quick fixes in the technology sector. If you’re not constantly innovating, you’re already behind. That’s why IBM’s revenue didn’t start to recover until the end of 2017.

Big Blue’s revenue growth, however, has recovered, on the strength of what the company has (uncreatively) called ‘“strategic imperatives.” The latter term refers to crucial business lines that weren’t an integral part of IBM’s lineup until recently. The imperatives are cloud computing, big data, security software, analytics, mobile, and social technologies.

The key for IBM stock will be growing its revenue from its strategic imperatives faster than the company has been losing ground on every other front.

That finally happened in the fourth quarter of last year, when IBM’s quarterly top line rose for the first time in years. Since then, the company has continued to deliver year-over-year revenue growth, although the modest level of those increases has continued to weigh on IBM stock. In the second quarter, for instance, the company’s sales rose just 4% y-o-y.

But something else curious also happened during Q2. For the first time ever, Big Blue’s strategic imperatives accounted for more than half of its $20.0 billion of total revenue. It’s also important to note that the revenue generated by the company’s imperative businesses surged 26% y-o-y.

So IBM’s fastest-growing businesses now generate the majority of its revenue, making it possible for the company’s sales growth to accelerate.

The  valuation of IBM stock is already favorable, with a forward-looking price-earnings ratio of only 10.5 that leaves plenty of room for upside.

Bottom Line for IBM Stock

If IBM’s sales growth does accelerate, IBM stock may start trending upwards again.That’s, of course,  still a big “if.” Indeed, it’s a huge “if.” But it’s one worth bearing in mind, not just on the morning of Oct. 16, but for the indefinite future.

As cliche as it sounds, the Q3 performance of IBM’s strategic imperatives could be a make-or-break moment for IBM stock, as those products and services have been around for a few quarters now. Growing those businesses right out of the gate is easy. Generating continued growth isn’t so easy.

Given the uncertainty surrounding the question of whether IBM’s revenue growth will accelerate, it might be wise to avoid holding IBM stock when the company reports its Q3 results. In the wake of the results, the movement of IBM stock, up or down, is sure to be large. But the knee-jerk reaction will pale in size to the potential long-term upside or downside of IBM stock over the longer term.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities. You can follow him on Twitter, at @jbrumley.

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