IBM Earnings: Still Plenty of Problems for Watson to Solve

IBM’s (IBM) Watson was supposed to be the savior of the company, right? Well, it seems that this amazing wonder of technology hasn’t solved all of IBM’s problems just yet.

IBMOn the heels of the latest IBM earnings announcement, IBM stock is off a painful 5%, bringing the 12-month return to a dismal -14%.

Let’s take a deeper dive into the IBM earnings release: In Q2, revenues plunged by 13% to $20.81 billion and earnings came to $3.84 per share. Yet the Street was expecting $20.93 billion on the top line. IBM was able to cut back on costs to beat on the earnings side (the Street estimate was $3.79 per share), helped by a lower tax bite.

But it’s the top line that really matters for investors. And there seems to be little evidence that things are on track. IBM’s revenues have been dropping consistently for 13 quarters.

At least the outlook is somewhat encouraging. The company affirmed its guidance for earnings of $15.75 to $16.50 per share of IBM stock. But again, the company will probably achieve those numbers by slashing away at the cost structure — not by driving significantly higher revenues.

IBM Stock Still Struggling to Catch Up

So then, why the problems with IBM stock? First of all, the company has a massive global footprint, so currency volatility has taken a big toll.

But there is another problem that is much more severe — and could mean further problems for IBM stock. Customers want technologies that are on the cutting-edge, such as cloud computing, big data and mobile apps. But for the most part, IBM is made up of crusty legacy software and hardware technologies.

Not that IBM is the only mega tech company that must deal with the wrenching transitions in the tech world. Just look at the slow growth at other companies like Oracle (ORCL) and SAP (SAP).

Now the good news for IBM is that it has a history of making successful strategic transformations, thanks to long-term relationships with many global companies. These relationships offer IBM a strong understanding of customer needs and issues.

For example, during the first half of this year, cloud revenues soared by 70%, with the annual run-rate at about $8.7 billion. IBM has also gotten lots of traction with its private and hybrid cloud systems, which allow for more scale and security.

Watson is showing more promise as well. The technology is deployed across nearly 30 countries and 20 industries, such as healthcare, retail, banking and finance.

Of course, it’s also true that IBM stock is trading at a cheap valuation, with a forward price-to-earnings ratio of only 10. By comparison, Oracle’s forward P/E is 13, SAP’s is 17, and Microsoft (MSFT) trades at 16 times forward earnings. IBM also sports a decent dividend yield of 3.2%.

However, the IBM transformation is still in the early phases — so the real gains may not happen until next year or even later. But for investors — who generally have short-term horizons — that’s a long time to wait with your fingers crossed. And even if you’re willing to wait things out, you have better options in the meantime.

In other words, IBM stock is likely to remain dead money until the company can finally show signs that growth is back.

Tom Taulli runs the InvestorPlace blog IPO Playbook. He is also the author of High-Profit IPO StrategiesAll About Commodities and All About Short Selling. Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.

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