So where's the growth? IBM's earnings climbed but sales fell.

07/17/2009 1:42 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

So where’s the revenue growth to keep the rally going?

The July 16 earnings results from IBM (IBM) were great news for IBM and its shareholders. The company did beat Wall Street earnings projections by 30 cents a share for the second quarter of 2009 when it reported $2.32 a share instead of the $2.02 Wall Street consensus. And gross profit margin did climb to 45.5% in the quarter from 43.2% in the second quarter of 2008.

But the news in IBM's report wasn’t nearly as good—in fact I’d call it downright stinky--for the stock market and the economy as a whole. IBM’s revenues dropped, 13.3% from the second quarter of 2008, and fell short of analyst projections by about $340 million. The weakness wasn’t limited to the United States either. Revenue fell for the Americas (down 9%), Europe/Middle East/Africa (down 20%), and Asia/Pacific (down 7%).

If one of the strongest companies in the world can’t generate some revenue growth, then those green shoots of economic recovery that everybody keeps talking aren’t enough to support a sustained increase in stock prices from current levels.

If you’re inclined to worry, as I am, not just about the amount of earnings growth that a company is showing but the quality of that growth, then IBM’s good news supplied plenty of reason for concern. One big contributor to rising margins in the quarter was the big decline in the company’s hardware sales, down 22% from the second quarter of 2008. Service revenue fell by only 12% and software revenue by only 7%. And since those two segments carry higher margins than hardware, those relatively smaller declines helped push margins higher.

That’s not exactly the kind of margin expansion that an investor wants to see quarter after quarter.

The other big contributor to margin growth and to the earnings surprise was continued cost cutting. SG&A expenses (selling, general, and administrative expenses) fell to 22% of revenue from 23.4% in the second quarter of 2008. Bravo to management but cutting expenses cuts harder every quarter.

If you're a growth investor want to you want to see is earnings growth that can be sustained quarter after quarter after quarter.

Investors in IBM should by happy with management. The company is running a tight ship, competing hard, and investing in its future—all the things a long-term investor would like to see. And with $3.4 billion in cash flow in the quarter and $12.5 billion in cash on hand at the end of the period, IBM is set for pretty much anything the global economy can throw at it. Investors who got $732 million in dividends in the second quarter and the benefits of $1.7 billion in stock repurchases can look forward to the same next quarter.

But I don’t see anything in those superlative results from IBM to convince me that stocks as a whole are worth more now than they were when the March rally peaked on June 12.

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