With the the S&P 500 breaking out to new all time highs after its recent consolidation on the heels of the second consecutive better than expected non-farm payrolls number this am, it makes sense to look for stocks that have lagged the broad market and have the potential to play catch up for more than just the reason of rising tides lifting all boats, possibly something fundamental. One such stock could be IBM, which despite out-performing the SPX year to date (up 18.5% vs 6.75%), it is still down about 25% from its all time and 52 week highs made in 2013.
IBM is a cheap stock at 12x expected 2016 eps and pays a dividend with a current yield of 3.45% which could be two of the reasons for the stock’s recent relative out-performance. The company is in the midst of a fairly epic revenue decline, with 2016 expected to be its 5th consecutive decline from its peak of $107 billion to $80 billion this year, but working very hard to move into faster growing businesses like its cognitive computing division (Watson). The good news though is that the rate of the sales decline is decelerating to an expected 3% in 2016 with consensus eyeing flat sales in 2017 & 2018.
I suspect one thing that could really catalyze the shares would be some sort of corporate action, possibly a trans-formative acquisition or the prospects of a split like of their hardware and software/services businesses like we saw from Hewlett Packard last year, with just this week rumors swirling around HPE (faster growing bit) being taken private, shares are at an all time high.
This October it will be CEO Ginni Rometty’s 4 year anniversary, and since then the stock is down about 20% vs the SPX up about 50%. I suspect the 30 year veteran of IBM needs to start thinking in terms of job security as a coach of a college sports team would where the athletic director was willing to give the new hire the benefit of their first class running their course.
If I were inclined to make a bullish bet that IBM’s Q3 results could hint towards an earnings and sales trough, and / or some sort of corporate shakeup to unlock shareholder value in the terms of a split, or M&A to stimulate growth, I’d be more inclined to create a trade structure that defines risk given the stock’s recent strength.
Short dated options prices are very cheap in IBM. which makes sense with spot VIX at 11.50, 30 day at the money implied volatility in IBM is at 52 week lows of 13.5%, with 60 day IV just below 18%, below the one year average:
The stock’s bounce of its 2010 low could signal a double bottom that has also propelled the stock above the downtrend that had been in place from its 2013 all time highs:
Near term, $150 appears to be decent technical support, with an air-pocket back towards the Q1 low below $120:
Cheap options prices, uncertain corporate recovery, messy global economy and 30% bounce off of the 2016 lows speaks to bulls defining their risk from here.
If I were inclined to play for a gap fill to $180 I might just buy and in the money call in October which will include their next earnings announcement.
IBM ($163) Buy Oct 160 call for $6.50
Break-Even on Oct Expiration:
Profits: above $166.50, up 2.1%
Losses: up to 6.50 between $160 and $166.50, max loss of $6.50, or 4% of the stock price.
*Stock goes ex-dividend on Monday morning, or $1.40 a share.
Rationale: This simple in the money call purchase defines risk to 4% of the stock price, for a stock that is up nearly 40% from its 52 week lows, while also offering just a 2% break-even presenting the opportunity to spread into a vertical call spread by selling a higher strike call on a move higher, thus reducing the premium at risk.