3 Reasons International Business Machines Corporation Stock Could Rise

By Markets Fool.com

Considering its 14% stock price appreciation so far this year and 3.6% dividend yield, 2016 has already been a decent year for IBM (NYSE: IBM) shareholders. Despite reporting a 3% decline in revenue last quarter, IBM stock is gaining momentum by delivering on CEO Ginni Rometty's strategic imperatives.

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IBM's focus on cognitive computing, security, big data, mobile, and social -- most of which are delivered via the cloud -- is paying off. Of course, if IBM stumbles along the way to completing its transformation, the tide will turn awfully quick. The flip side of a possible trip-up is if IBM does deliver in a few strategic areas, shareholders could enjoy another banner year of gains. Let's look at what could push the stock higher.

Image source: IBM.

It all starts here

As investors learned last quarter, IBM is betting the farm on its strategic imperatives units. In the first six months of 2016, IBM inked 11 acquisitions totaling over $5 billion. Virtually every one of IBM's deals was done to give a boost to one or more of its strategic imperatives businesses. Though it's too early to determine the impact the deals will have, based on IBM's second-quarter earnings, they're not hurting its results.

With a trailing annual run rate of $11.6 billion, IBM's combined cloud sales are alongside Microsoft's (NASDAQ: MSFT) more than $12.1 billion near the top of the provider list in the burgeoning market. Just the public cloud services market -- IBM's suite of solutions also includes private and hybrid cloud sales -- is forecast to exceed $200 billion this year.

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Booming cloud sales, along with increases in IBM's other strategic imperatives components, generated a combined $8.3 billion last quarter, and on a 12-month trailing basis the core group now account for 38% of total sales. Rometty's objective is to increase strategic imperatives to 40% of annual sales by 2018. If IBM is able to reach that goal this year, which it should given its consistent quarterly improvements, its stock should rise even further.

Turn the page

One of the statistics IBM surely dislikes hearing the most is that last quarter's 3% drop in revenue compared to the year-ago period was its 17thstraight. Ouch. However, once that string is broken, even investors who have sat on the sidelines will likely take a closer look at IBM stock -- and rightfully so.

The companywide transformation Rometty has overseen since her reign as CEO began nearly five years ago was always going to take some time. Thing is, Microsoft and its two-pronged "mobile-first, cloud-first" transition is as significant as IBM's, yet after accounting for charges, it actually increased total revenue 2% to $20.6 billion last quarter. In other words, it can be done.

When IBM joins Microsoft and moves beyond its unpleasant quarterly slump and grows total revenue year over year, it will confirm to the naysayers that its transformation efforts have paid off, which in turn would be the impetus some investors need to get onboard.

Tighten the purse strings

Considering the aforementioned $5 billion plus in acquisitions this year along with an increase in research and development (R&D) costs, it's not surprising IBM's expenses over the first six months of this year climbed nearly $1.7 billion to $14.3 billion, a 13% increase. The result has been an enhanced product and services suite of solutions that's right in line with IBM's strategic imperatives push, but it's also put a damper on gross margins, and that rolls downhill to earnings-per-share (EPS) declines.

Other than IBM's systems unit, which maintained its 56.5% gross margin last quarter, each of its other four divisions declined because of rising costs. With its strategic imperatives momentum in full swing, IBM stock would warrant an increase once its earnings per share (EPS) and margins return to past levels -- and tightening the purse strings would go a long way toward making that happen.

Despite its ho-hum analyst "hold" rating -- IBM stock is already above its consensus average price target of $156.48 a share -- it's valued at a mere 11 times forward earnings. If it's able to drive results in key areas, combined with its relative value and industry-leading dividend yield, IBM stock should continue to rise.

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Tim Brugger has no position in any stocks mentioned. The Motley Fool owns shares of Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.