IBM- Death by 1000 Cuts

IBM’s fourth quarter featured another batch of accounting-related benefits

Many of the one-time earnings benefits we come across are relatively minor. For example, a company that earned $1.00 per share may have benefited from its effective tax rate declining by 50-70bp which added 1 cent to EPS. Or, its credit loss reserves may have declined slightly to add 2 cents. Neither situation by itself is cause for excessive alarm if they happen once and no similar benefits appear for several periods.

However, it becomes a concern when a company routinely manages to beat forecasts by employing accounting gimmicks. Suddenly, 1 cent here, 3 cents there starts adding up to become a meaningful percentage of reported earnings and earnings growth. Now the issue becomes what are the real earnings and what happens if some of these gimmicks cannot repeat? It is tough to reduce an expense below zero or book a credit to an allowance for multiple quarters. The company may rely on finding 10-20 cents of these short-term items or aggressive assumptions to make their earnings every quarter. People who do not look behind the curtain may be taking on higher risks than they realize.

IBM is the perfect example of a company whose quarters regularly contain multiple unusual benefits that add meaningfully to earnings growth. We will take a closer look at the latest quarter below.

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