IBM: With Not Enough Evidence Of Successful Turnaround, Stock Could Be Value Trap

As December comes to a close, International Business Machines (NYSE:IBM) has bounced upwards from the YTD low close of $115.81 on Nov. 26, so the 12-month total return for IBM now stands at consensus rating is bullish and the consensus 12-month price target is $145.35, 15.39% above the current share price. In contrast to E-Trade’s analyst cohort, the number of analysts assigning a neutral rating substantially outnumbers those who assigned a buy rating.

Source: Investing.com

These two versions of the Wall Street consensus agree on a bullish rating and that the shares have expected double-digit price appreciation potential for the next year, although they differ somewhat on the magnitude. Averaging the consensus 12-month price targets from E-Trade and Investing.com (19.4%), the expected total return (including the dividend) is 24.6%.

Market-Implied Outlook for IBM/h2

I have calculated the market-implied outlook for the 5.9-month period between now and June 17, 2022 by analyzing the prices of options that expire on that date. I have also generated the 13-month market-implied outlook using options that expire on Jan. 20, 2022. I selected options at these two expiration dates to provide a view to the middle of 2022 and through the entire year.

The standard presentation of the market-implied outlook is in the form of a probability distribution price return, with probability on the vertical axis and return on the horizontal.

Source: Author’s calculations using options quotes from E-Trade

The market-implied outlook to the middle of 2022 is almost symmetric, with comparable probabilities of positive and negative returns, although the peak in probabilities is slightly tilted to favor negative returns. The annualized volatility calculated from the distribution is 27.1%.

To make it easier to directly compare the probabilities of positive and negative returns, I rotate the negative return side of the distribution about the vertical axis (see chart below).

Source: Author’s calculations using options quotes from E-Trade. The negative return side of the distribution has been rotated about the vertical axis.

From this view, it is evident that the probabilities of negative returns are slightly higher than for positive returns. Theory suggests that the market-implied outlook will tend to be biased to favor negative returns because investors tend to be risk averse and thus willing to pay more than fair value for downside protection (put options).There is no robust way to test for this bias. Given the potential for a negative tilt, however, this market-implied outlook is best interpreted as neutral.

Looking all the way through 2022, calculating the 13-month market-implied outlook, the view has shifted to look somewhat bearish. The relative spread between the probabilities of positive and negative returns is more pronounced. There is a distinct, albeit modest, peak in probability corresponding to a price return of -8% for this period. The annualized volatility calculated from this distribution is 26.7%.

Source: Author’s calculations using options quotes from E-Trade. The negative return side of the distribution has been rotated about the vertical axis.

The market-implied outlook for 2022 is neutral to the middle of the year, but slightly bearish for the year as a whole. The expected annualized volatility, about 27%, is not especially high or low for an individual large-cap stock.

Summary/h2

IBM has been struggling for years and is somewhat behind in the large-scale migration to the cloud. While the dividend yield is high and the current valuation is low, the concern is that IBM could end up being a value trap.

The Wall Street analyst consensus is bullish, with expected 12-month total return of almost 25%. This magnitude of gains will require evidence of substantial earnings growth. By contrast to Wall Street, the market-implied outlook for IBM for the next year is slightly bearish, with elevated probability of price declines.

Given the challenges associated with changing the direction of large companies, as well as the rapidity with which the cloud economy is progressing, it is hard to be very optimistic about IBM. In balancing the bullish outlook from Wall Street with the slightly bearish view from the options market, I am maintaining my neutral view on IBM.