Here’s Why It’s Time to Sell IBM

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Three weeks ago I wrote an article in which I argued that IBM (NYSE:IBM) shares were getting ready to trade higher. There were two reasons for this. The first was that the stock had gotten oversold at $180 per share, and that demand coming from (a) value investors trying to bottom fish, (b) the company itself buying back stock, and (c) short sellers taking profits would give the shares a boost. Second, there was reason to believe that the company’s second-quarter earnings would be received well, and that optimism would build going into the announcement given that a onetime charge in the second quarter of 2013 would make this quarter’s earnings look promising.

Since then, we have seen the stock rise to $192 per share, and earnings have come out. The reported figures beat estimates, and as I expected, the report showed sizable earnings growth. But because of the onetime item in the second quarter of last year, this earnings growth is illusory. In fact, the data show signs of continued deterioration, and I think it is time to take profits in IBM, assuming you took my trade advice. Furthermore, it makes sense to hold a bearish view of IBM for the intermediate term.

The problem with IBM is that it has a lot of its business tied up on the hardware segment, which is undergoing a secular decline as computer hardware products are becoming commoditized. This essentially means that they are becoming easier to make and that there are more competitors entering the space. All of these competitors are competing on price. While IBM has entered other business segments, such as cloud computing and services, the growth from these segments cannot compensate for the lost revenue and profits in hardware.

As a result, we have seen several years now in which IBM has reported year-over-year sales declines. While the company has generally reported earnings per share growth, this has lately been due to the company’s aggressive stock buyback program, which has reduced the total number of shares outstanding. More recently, the company has reported year-over-year profit declines, and finally, in the first quarter of this year, the company reported a year-over-year decline in earnings per share, which couldn’t be stopped despite the buyback program.

While the company reported a 28 percent increase in income in the second quarter ($4.1 billion versus $3.2 billion), this increase is offset by the aforementioned onetime charge of $1 billion. Accounting for this, we actually see yet another decline in income.

While the stock has been relatively weak, I don’t think it has been sufficiently weak in the context of this long, drawn-out decline in sales and profits. There are several reasons for this, including (a) demand for the stock generated by the company buying its own shares, (b) the company’s longstanding reputation as a solid investment, which has many people convinced that we will see the company’s earnings rebound in the not-too-distant future, and (c) the endorsement of Warren Buffett, who has been buying the stock aggressively for his Berkshire Hathaway. But none of these factors improves the underlying fundamental for the company.

With this in mind, my bearish thesis is playing out, and I would sell the shares and look for opportunities elsewhere in the market.

Disclosure: Ben Kramer-Miller has no position in IBM or in any of the stocks mentioned in this article.

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