(Updates share price)ARMONK, N.Y. ( TheStreet) -- IBM's ( IBM) stock is coming under selling pressure, despite the tech bellwether's strong third-quarter results Thursday. Shares of IBM, which is seen as a key indicator for the health of the IT sector, fell $6.08, or 4.8%, to $121.91 in early trading Friday, outpacing the broader retreat in tech stocks that saw the Nasdaq dip 0.7%. With expanding margins and slight sequential sales growth, IBM performed well in the third quarter. Some analysts, however, say that there could be more upside elsewhere in the tech sector. "Impressive execution continues to be driven by IBM's focus on strategic business units, for example, IT services and software, with higher associated margins coupled with tight cost controls," wrote Brian Marshall, an analyst at Broadpoint AmTech, in a note released Friday. "However, we continue to prefer IBM's business partners such as NetApp ( NTAP) and Brocade ( BRCD) at this point in the economic recovery cycle." Brocade and NetApp have already been touted as potential acquisition targets on account of their strong product stories, and Marshall believes that both firms offer faster growth profiles and higher operating leverage than IBM. Goldman Sachs analyst David Bailey also thinks that investors should look beyond Big Blue. "IBM's small top- and bottom-line beat in Q3 are probably not enough to sustain the recent up-move in the stock and our rating remains Neutral," he wrote, in a note released Friday. "We continue to favor stocks with greater top-line growth and margin expansion potential, including NetApp, Arrow ( ARW), Seagate ( STX), and Molex ( MOLX)."
IBM's stock has risen 45% this year, as investors have warmed to the company's growing reputation as a recession-buster. One of the big success stories of the economic slowdown, IBM continued its margin growth in the third quarter, despite year-over-year revenue declines in most of its business units. Software led the way during the third quarter with a gross profit margin of 85.7% and the company pushed its overall margin up by almost two percentage points to 45.1%. "Software was the key profit driver for IBM during its expansion over the past six years, and continues to drive profit growth even during the recession," wrote Allan Krans, a senior analyst at TBR, in a note released Friday. "Although IBM was outpaced in growth by more aggressive competitors such as Microsoft ( MSFT) and VMware ( VMW) during positive economic conditions, IBM Software is maintaining much more consistent performance during the recession." Microsoft, in contrast, has been hit with falling sales, and VMware has seen a significant slowdown in its recent explosive growth. Hot on the heels of Intel's ( INTC) third-quarter results, IBM's numbers have also been cited as further evidence of a tech recovery. "Overall, sequential improvement in hardware and services and flattish software sales provide another indication that demand is beginning to improve," wrote Goldman Sachs' Bailey. "
But for Hardware, IBM's limited revenue and earnings upside reinforces our shift from companies with earnings resiliency to those with more robust top-line growth and operating leverage." Revenue from IBM's Systems and Technology group fell 12% year over year, but was flat compared to the prior quarter. IBM CFO Mark Loughridge nonetheless struck a bullish tone during a conference call to discuss the results Thursday.
"These results will substantially outperform the industry, gaining share in Systems & Technology, in servers, and in storage," he said. "We now expect the Systems & Technology Group to deliver double-digit profit growth in the fourth quarter." The finance chief also took a swipe at IBM's software rivals, explaining that the company is gaining share against Microsoft and Oracle ( ORCL). Loughridge's comments came just a few days after Oracle chief Larry Ellison vowed to challenge IBM through his firm's Sun ( JAVA) acquisition. The two companies are clearly suiting up for battle. -- Reported by James Rogers in New York