- IBM shares have been in decline over the past 5 years
- The current dividend yield is 5.2%
- The Wall Street consensus view continues to be bullish
- The market-implied outlook (calculated from options prices) is slightly bearish for 2022
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 11.7%.
Even with its current dividend yield of 5.2%, IBM’s total 12-month return is less than half that of the S&P 500. IBM shares have returned a total of -0.17% per year for the past 5 years, a period over which the S&P 500 has averaged more than 17% per year. The opportunity cost for investors over this period is enormous.
Source: Investing.com
Arvind Krishna was installed as CEO of IBM in early 2020, with a mandate to turn Big Blue around and restore the information technology services firm’s position as a sector innovator and leader. The company lagged in scaling cloud services, but has since been advancing in this key area. IBM reported disappointing revenue numbers for Q3 on Oct. 20, triggering a sell-off in the shares.
There are many historical examples of industry-leading companies that failed to continue innovating and keep up with their markets. The classic paradigm for explaining how this happens is outlined in The Innovator’s Dilemma by Clayton M. Christensen. IBM has navigated similar major shifts in direction in the past, but the market appears to be losing patience.
I last analyzed IBM on Aug. 25, almost 4 months ago. At that time, the forward dividend yield was 4.7% and the forward P/E was 13. The Wall Street analyst consensus rating was bullish. Today, the forward P/E is 12.6 and the forward yield is 5.2%.
At that time, I assigned a neutral rating and a key factor in my decision to discount the analysts’ bullish view was that the options market was sending a moderately bearish signal to the middle of 2022.
The options market provides important information about what the market expects from a stock. The price of an option on a stock reflects the market’s consensus estimate of the probability that the stock price will rise above (call option) or fall below (put option) a specific level (the option strike price) between now and when the option expires. By analyzing the prices of call and put options at a range of strikes, all with the same expiration date, it is possible to calculate a probabilistic price return outlook that reconciles the options prices.
This is referred to as the market-implied outlook and represents the consensus view from the options market. In late August, the 9.7-month market-implied outlook to June 17, 2022 (calculated using options that expire on that date) indicated elevated probabilities of price declines. In the (roughly) 4 months since that analysis, IBM’s price has fallen 5.8%.
I have generated updated market-implied outlooks for IBM through 2022 to see how things have changed in recent months as compared with the current Wall Street consensus outlook. While IBM looks cheap on the basis of fundamentals, the key unknown is earnings and revenue growth. For these, the most sensible approach is to examine the range of expected values as reflected in these two forms of consensus outlooks.
Wall Street Analyst Consensus Outlook for IBM
E-Trade calculates the Wall Street consensus outlook by aggregating the views of 8 ranked analysts who have published ratings and price targets for IBM in the past 90 days. The consensus outlook is bullish and the consensus 12-month price target is $155.16, 23.46% above the current share price. Of the 8 analysts, 5 are bullish and 3 are neutral.
When I analyzed IBM on Aug. 25, the consensus price target was $154.33, so the analyst view has barely moved in the past 4 months, even after the disappointing Q3 revenue report.
Source: E-Trade
Investing.com’s version of the Wall Street consensus is calculated from the views of 19 analysts. The 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
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
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.