Why IBM Stock Is Falling Despite Strong Earnings Results

IBM IBM shares declined. on Thursday after the tech giant reported disappointing growth for a key part of its software division that offset better-than-expected third-quarter results and boosted sales forecasts. IBM stock fell more than 7% pre-market.

Armonk, New York-based IBM said it earned an adjusted $2.65 per share for the quarter ended in September, up 15% from a year earlier. That exceeded the $2.45 per share that analysts polled by FactSet had expected. Sales rose 9% to $16.3 billion compared to analyst estimates of $16.1 billion.

IBM CEO Arvind Krishna praised AI’s business track record of more than $9.5 billion, according to IBM’s press release. One year ago, Krishna said IBM’s AI business book had reached about $3 billion.

Meanwhile, IBM now expects revenue growth of more than 5% for the full year, compared to language in previous Q2 results that expected “revenue growth of at least 5%.” Furthermore, IBM said it expects free cash flow of about $14 billion for the full year, compared to a previous forecast of $13.5 billion.

In recent pre-market trading on the stock market today, IBM stock fell more than 7% to 265.20.

IBM’s software segment meets the views; Slow growth of red cap

Analysts at Morgan Stanley pegged IBM’s software segment revenue as the “single most important metric” in the report. Investors may be looking for further upside. Software revenue rose 10% to $7.21 billion, according to IBM. That was roughly in line with analyst expectations, according to FactSet.

But IBM’s hybrid cloud software offering, Red Hat, had 14% year-over-year sales growth. This was a slowdown from 16% growth in the second quarter.

“The big question in the print was the slowdown at Red Hat versus mid-teens growth expectations,” Evercore ISI analyst Amit Daryanani wrote to clients late Wednesday. He rates IBM shares an Outperform or Buy.

However, Daryanani noted that stronger-than-expected growth for IBM’s automation and transaction software businesses could help offset Red Hat’s slowdown in IBM’s December quarter. The Automation Software segment includes contribution from IBM’s recent acquisition, HashiCorp.

Instead, IBM’s revenue rise was fueled by its infrastructure segment, which got a boost from sales of IBM’s new AI-focused Z17 mainframe. Infrastructure sales rose 17% year over year to $3.56 billion, compared to estimates of $3.46 billion.

Consulting revenues were also stronger than expected. Sales from this segment rose 3% year over year to $5.32 billion, compared to expectations of $5.24 billion.

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IBM shares are up 33% this year

Before earnings, IBM rose 2.2% in regular trading on Wednesday. Shares were up 33% year-to-date.

Overall, investors have been positive about IBM’s shift to focus on software growth, as well as its ability to leverage artificial intelligence.

However, Thursday’s action marks the third straight quarter in which IBM stock has fallen following its quarterly results. In each of these reports, IBM beat top and final estimates but fell on concerns about the performance of its software segment.

Jefferies analyst Brent Hill reiterated a Neutral rating on IBM following Wednesday’s results. He said there are positive signs that IBM’s software growth will accelerate soon, but “it will remain on the sidelines until we see more signs of consistent software implementation.”

IBM — one of 30 stocks that make up the Dow Jones Industrial Average — has easily outperformed the S&P 500 this year, including an early decline on Thursday. But its relative strength rating fell to 71 out of the best possible 99 points as of market close on Wednesday. The stock had a score of 85 three months ago.

At the release of the third-quarter report, IBM shares received an IBD Composite Rating of 84 out of a top 99, according to IBD Stock Screener. The score combines five separate property ratings into one rating. The best growth stocks have a Composite Rating of 90 or better.

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