Strategic shift pays off for IBM

In the past few years, IBM has steadily moved away from less-profitable “commoditized” products, like printers and home computers. Instead, the company is offering more computer services and software. These generate higher profit margins, and help businesses cut costs and improve productivity. Moreover, the shift is helping IBM make higher profits, even with a slower global economy.

IBM $121.29 (New York symbol IBM; Shares outstanding: 1.3 billion; Market cap: $159.3 billion; SI Rating: Above Average) is the world’s largest computer company, with operations in over 170 countries. IBM specializes in making large mainframe computers for governments and corporations. The company is also the world’s second-largest software maker, after Microsoft Corp. IBM gets 22% of its revenue from sales of software.

IBM’s service division now supplies almost 60% of it’s revenue. As well, long-term contracts for designing and maintaining computer systems provide steady revenue streams. This cuts the company’s risk.

In the three months ended September 30, 2009, the slower economy pushed down revenue by 6.9% to $23.6 billion from $25.3 billion a year earlier. However, IBM’s earnings rose 13.8%, to $3.2 billion from $2.8 billion, because of its shift to services and software, which generate higher profit margins. Earnings per share rose 17.6%, to $2.40 from $2.04, on fewer shares outstanding from share buybacks.

With cash of $11.5 billion, IBM can continue to make acquisitions to expand its service and software offerings. Its high research spending ($1.4 billion, or 6.1% of revenue, in the latest quarter) will also let it keep adding profitable new products in a highly competitive market.

IBM is still a buy.