While I’m bullish on International Business Machines (NYSE:IBM) and its longer-term potential, I must admit that it’s a frustrating investment. Early this year, the IBM stock price got off to a brilliant start, recovering from the collapse that occurred in the calendar fourth quarter of 2018. But since mid-February, shares haven’t netted much gains for stakeholders.
To drive firmly out of its horizontal trading range, many observers hoped that Big Blue’s third-quarter 2019 earnings result would provide the catalyst for International Business Machines stock. As our own Vince Martin stated prior to the disclosure, Q3 was pivotal to establish the narrative. For instance, IBM made a risky acquisition of cloud services provider Red Hat. To Martin’s point, the buyout made sense, but it wasn’t cheap.
When the dust settled on the Q3 report, investors didn’t like what they saw. Although IBM beat the consensus target for earnings per share, the margin of victory (a penny up) wasn’t impressive. Not only that, EPS was down almost 22% from the year-ago quarter, which didn’t look good for IBM stock.
But the most critical factor was the revenue miss. Analysts expected $18.22 billion. Instead, the technology giant rang up only $18.03 billion. Adding to the woes, this current revenue haul was nearly 4% lower than Q3 2018 sales results.
Not surprisingly, Wall Street penalized the IBM stock price, which saw a swift drop below its 200-day moving average. Fortunately for stakeholders, International Business Machines stock has proven resilient, gradually inching higher from the disappointing Q3 report.
Naturally, investors want to know if this resilience means something. And I think it does because the Street is simply lacking patience.
Red Hat Isn’t Just a Trophy for IBM Stock
Part of the reason I believe investors have taken a dim view on the IBM stock price is the lack of understanding about the cloud business. Don’t get me wrong: I’m not pointing a critical finger at anybody.
All it takes is a quick look at market share statistics to get discouraged about chasing International Business Machines stock. The ultimate disrupter, Amazon (NASDAQ:AMZN), leads by a wide margin over Microsoft (NASDAQ:MSFT). Then comes Alibaba Group (NYSE:BABA), Alphabet (NASDAQ:GOOGL) and IBM to round out the usual suspects.
Although the initial optic doesn’t look favorable, investors should consider the broader picture. Although cloud computing as a general concept has a long history, we’re still in the early stages of adoption; a dominant company today may not be so dominant several years from now.
That by itself doesn’t provide an automatic pathway to upside for the IBM stock price. However, Big Blue is uniquely positioned in that its myriad businesses provide a synergistic platform for enterprise-level clients.
According to Gartner analyst Sid Nag, Amazon risks market “erosion” as other cloud vendors offer additional features. Furthermore, as a complete service provider, Amazon lags its tech-centric competitors. In Nag’s words, mostly focusing on infrastructure “becomes less sexy.”
In contrast, IBM’s acquisition of Red Hat enables more scalable usability across a diverse spectrum. As open source specialists, Red Hat can ensure that clients are paying for exactly what they need. Just in efficiency alone, the subsidiary can drive more clients to Big Blue, thereby lifting the bull case for IBM stock.
Moreover, the Q3 report demonstrated substantive results for the acquisition. IBM reported 20% year-over-year growth for Red Hat, comparing favorably to the roughly 14% growth in the quarter ending Sept. 30, 2018.
Competent Cloud Coverage
One thing to keep in mind when assessing the IBM stock price is to avoid immediacy bias. While Amazon appears poised to dominate the cloud indefinitely, that may not be the case.
We can look at recent history to provide real-world examples. For instance, Nokia (NYSE:NOK) once dominated the cellphone market. But Apple (NASDAQ:AAPL) came up with not only a better product, but a far superior ecosystem.
And the ecosystem offers the biggest potential for International Business Machines stock in terms of cloud coverage. Under IBM’s umbrella, you have extensive synergies with artificial intelligence, cybersecurity and various services for high-level clients. Put another way, IBM is one of few companies that can competently drive the cloud narrative for years to come.
Finally, the Q3 report confirmed the expanding demand picture for Red Hat. In my opinion, that should have been the main focus of the earnings results. Nevertheless, the markets lack of appreciation for this story provides an undervalued opportunity for IBM stock.
As of this writing, Josh Enomoto did not hold a position in any of the aforementioned securities.