International business machines (NYSE: IBM) just experienced one of the biggest daily declines in its history. This 25% decline on Tuesday came after CEO Arvind Krishna admitted that heavy investments in hardware had led many companies to shift their budgets away from software spending.
Such a sharp market reaction will understandably leave many investors wondering how to respond. However, there are good reasons to view this dip as a buying opportunity.
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Why IBM was sold
Admittedly, the negative reaction to Krishna’s statement was understandable. According to IBM’s preliminary second-quarter results, the company’s revenue increased just 1% year-over-year. That’s well below the 9% increase in the first quarter and brought revenue growth to levels comparable to IBM’s before Krishna shifted the company’s focus to the cloud and AI.
Software is now IBM’s largest business segment, accounting for nearly 45% of the company’s revenue in the first quarter. Additionally, the annual growth rate of the software segment fell from 11% in the first quarter to just 5% in the second quarter.
Additionally, while IBM still operates an enterprise hardware business, its infrastructure segment posted a 7% annual revenue decline in the second quarter. Therefore, it does not appear to have benefited from the boom in hardware spending.
Why investors should remain confident
The only upside for investors, however, is that this tech stock’s decline appears to have immediately priced in this particular challenge. IBM’s P/E ratio is currently just 19, close to its multi-year low. Last fall the earnings multiple was over 40, so this decline represents a significant discount.
Additionally, under Krishna’s leadership, IBM’s total returns exceeded S&P 500This shows that he has earned the trust of investors during his six years as head of the company.
IBM Total Return Level data from YCharts.
Not all of the news in the preliminary report was negative either. Red Hat’s second-quarter revenue growth was 11% year-over-year, suggesting there are still bright spots in IBM’s software business.
Additionally, the US government is betting billions on quantum computing, and IBM has long been a leader in this technology. As part of its partnership with the government, IBM announced plans in May to build Anderon, the first pure-play foundry to produce quantum wafers.
In addition to the $2 billion investment in the foundry (including $1 billion from CHIPS Act funds), $10 billion in quantum technology investments is planned over the next five years. Such investments significantly increase the likelihood that IBM will be a major player in a technology that is expected to drive innovation in the coming years.
Buy IBM shares
Difficulties in the software sector and IBM’s 1% revenue growth in the second quarter are likely to continue to weigh on the stock in the near term.
Fortunately, despite the selloff under Krishna, IBM stock has thrived and appears to be on track to continue to outperform over the longer term.
Additionally, Red Hat’s continued success and its investments in quantum computing should serve IBM well in the coming years. With this growth story now selling for just 19 times earnings, Tuesday’s plunge could be a blessing in disguise for new investors.
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Will Healy does not hold a position in any of the stocks mentioned. The Motley Fool has positions in and recommends International Business Machines. The Motley Fool has one Disclosure Policy.
IBM crashed after issuing a warning for the software sector. Time to buy? was originally published by The Motley Fool
https://finance.yahoo.com/markets/stocks/articles/ibm-plunged-issuing-warning-software-085000729.html
