IBM: The Numbers Don't Add Up...

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While I was reading the paper this morning, I caught a short interview on CNBCÂ with Toni Sacconaghi, Bernstein’s analyst covering International Business Machines Corp (IBM). During the interview, he said a few things that caught my attention; I’d like to discuss them in a bit more detail here.

Early on in the interview, Mr. Sacconaghi was asked about the company’s sluggish top line growth over the past ten-plus years: as he noted, revenue growth, excluding acquisitions and divestitures, has only been ~1% per annum over the past decade.

For Mr. Sacconaghi, this was a point of contention: “I think what IBM really needs to show is that it can [report] top line growth.”For readers who follow IBM, this won’t come as a surprise: it seems that everybody who follows the company believes that revenue growth, above all else, is critical to IBM’s future. That certainly doesn’t sound like an absurd claim to make.

Yet this is where things get a bit muddled: shortly thereafter, Mr. Sacconaghi noted something else about IBM – “it’s been a very good stock” over the last ten or fifteen years.

Let’s put some numbers on that: over the last decade: IBM has moved from ~$93 per share to ~$163 per share; over that same period, the company paid another ~$24 in cumulative dividends to investors. Assuming that was all received today, the 10-year CAGR for IBM was 7.2%; considering the sluggish top line growth, that doesn’t sound like too bad of an outcome.

But that’s not the end of the story. In 2005, when the stock was trading at ~$93 per share, the company would report just under $5 per share in earnings; the market was willing to pay 19x earnings for IBM back then.

Compare that to today: on the $15.69 (GAAP) that IBM earned in 2014, Mr. Market’s current opinion ($163 per share) values the shares at less than 11x earnings.

The P/E has contracted by roughly 45% over the last ten years – enough to reduce the growth in the stock price by more than five points a year; earnings per share, which has increased from $4.47 in 2004 to $15.69 in 2014, has increased at a compounded annual growth rate of more than 13% over that same period.

As the interview went on, Mr. Sacconaghi returned to his earlier point, making the argument for his current view on the stock: I don’t think IBM will be able to grow its top line over the next two or three years. It’s hard to say and look beyond that.”

Nobody bothered asking about the gaping hole between revenue and earnings growth…

Conclusion

From my perspective, there’s really only two things I’d want to know from here: how did IBM manage to grow EPS at more than 13% a year on 1% organic EPS growth, and is that sustainable going forward. You can answer the first one by going back and reviewing the company’s results for the last 10+ years; that’s a revealing exercise that I’ll leave for interested readers to pursue on the their own. Answering the second question – the one that really matters – is the hard part.

One last point: shares outstanding have declined from 1.68 billion to 1.00 billion (-40%) over the past ten years (to the end of 2014). That’s enough to boost EPS by ~5.2% each year over the measurement period – leaving us to account for the other eight points of annual earnings growth. Anybody who believes IBM’s earnings per share growth has been purely driven by billions in share repurchases hasn’t looked at the numbers; it’s accounted for less than 40% of the move since 2004.