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I Wouldn’t Chase International Business Machines Corp. At This Level

IBM stock is up big, but upside feels limited from here

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This earnings season already has a theme. Another day, another blowout earnings report, another high for the market.

IBM Stock Is Ready to Surge
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Today’s earnings darling is International Business Machines Corp. (NYSE:IBM), the often forgotten tech giant, which has received support from famed investor Warren Buffet but hardly anyone else. IBM beat the Street numbers, including the biggest top-line beat in recent memory.

The biggest news from IBM’s third-quarter report? It looks like revenue growth may actually be positive next quarter. That would mark a critical inflection point for the IBM growth narrative, which has suffered from 22 consecutive quarters of revenue declines.

No wonder IBM stock is up about 9% in early Wednesday morning trade.

Is this a rally worth chasing? After all, IBM stock is still well off its $180 February highs and looks to be headed back there now that positive revenue growth is right around the corner.

But I don’t think IBM gets back to $180 anytime soon. Here’s why.

Revenue Growth Is Coming, But It Won’t Be Anything Big

Around 45% of IBM’s business is classified as Strategic Imperatives. This is the part of IBM’s business that is growing. It includes the cloud business (revenues +20% last quarter), the security business (revenues +49%), the mobile business (revenues +7%), the analytics business (revenues +5%), and the social business (flat revenue growth).

Altogether, Strategic Imperatives revenue rose 10% year-over-year last quarter. That is an acceleration from the second quarter (+7%).

The other 55% of IBM’s business is in secular decline, and it will remain so. But as the Strategic Imperatives business scales and counts for a bigger and bigger slice of the IBM revenue pie (45% last quarter versus 40% in the same quarter one year prior), revenue declines are moderating. This trend will continue, implying revenue growth is coming quite soon.

It looks management expects revenue growth to kick in next quarter, based on comments that sequential revenue growth in Q4 should exceed $2.5 billion.

But the revenue growth IBM is looking at over the next several years is very, very low. Strategic Imperatives revenue growth is already slowing year-over-year (10% versus 15% one year prior), so this growth rate will likely continue to moderate into the foreseeable future. All in all, with Strategic Imperatives growing below 10%, IBM is looking at flattish revenue growth potential over the next several years (my best guess is growth will run in 0-1% range).

That isn’t exactly exciting, especially against the backdrop of continued gross margin erosion. Management does expect margins to rebound next year, but only by a fractional amount (30 to 50 basis points). Tepid margin expansion and tepid revenue growth imply a pretty unexciting earnings growth outlook for IBM over the next several years.

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