IBM: Why It Now Is A Market-Maker Favorite

| About: International Business (IBM)

Summary

IBM has looked cheap for over six months; why is now a time to buy?

Is Watson developing into a product instead of a service?

Where do market-maker value ideas come from?

It's hard for an IBM to sneak up on the market

With a $130 billion market-cap, trading $700 million a day, and 1800 funds and institutions owning 60% of the stock and $50+ billion in public investor hands, lots of folks stay interested in IBM (NYSE:IBM).

But, as the saying goes, "things always look darkest just before they go totally black."

Here is how the market pros have evaluated IBM's price range prospects over the last two years.

Figure 1

(used with permission)

The vertical lines in this picture are forward-looking forecasts of coming price prospects, updated weekly from the real-money bets made by market-makers [MMs] to hedge firm capital put at risk to help big-$ fund clients get volume [block] trades filled. The heavy dot in each price range estimate is the closing price on the day of the forecast.

About a year ago the upside-to-downside split of the expectations got very heavy on the up, skinny on the down, and IBM's market quotes rallied. But after they reached the tops of most earlier-in-that-year outlooks, the rally ran out of follow-through. What is now a two-year falling knife scares many.

Where do MMs get their value notions?

From the other 1800 players at the poker table. For the MMs, what matters is not EPS in 2017 or 2020, but what bids and bluffs are likely in the next few weeks or months. Those time boundaries are dictated by the brief life-spans of the derivative instruments used to hedge their capital put at risk while "facilitating" the balance of buyers and sellers many times a day to get volume trade orders filled. Orders from organizations with the money muscle to move market prices.

What it costs to buy the risk-transfer insurance, and which securities are involved, define the price range boundaries seen by the hyper-sensitive, well-informed, and well-paid players in these tight markets. Neophyte speculators should listen to angels about treading there.

So, has there been any change in the outlook?

Figure 2 shows the last six months of daily updates, from which Figure 1's weekly excerpts were drawn.

Figure 2

(used with permission)

Our attention to the recent, brief, rise in both IBM's price and the MMs' outlooks was prompted by the House of Morgan raising their announced enthusiasm and price expectations for the stock. What do they know that we (and others) don't? Why now?

They set a target of $140, only about +10% above its close last night. Our read of the hedge-driven MM forecasts is $137+, a +9% prospect, which can be seen in the row of data in Figure 2.

The balance between upside and downside prospects is measured by the Range Index [RI], now at 17. With 17% of the expectations range below the $126 market price the other 83% is to the upside. The blue thumbnail picture at the bottom of Figure 2 shows the current RI to be on the value side of the last 5 years' distribution of daily measures.

For many stocks this is quite constructive and supportive for holders or interested buyers of IBM. But is IBM a value stock? Or a momentum stock?

A look at the 261 prior RI instances (about a fifth of the 1261) at 17 tells that only one in three (33 of each 100) wound up reaching its upside forecast target. Or three months after the forecast, when those targets were not reached, was at a price above its next-day-after-forecast cost price.

The average price change of the 261 prior experiences was -3.6%, with an average holding period of 62 market days. Since there are 63 market days in 3 months, darn few of the 261 actually reached upside targets. Comparing the negative payoffs against any positive upside forecast produces a dreadful credibility ratio, shown in Figure 2 as -0.4. Value investors would like to see a cred ratio at least close to +1.0, if not above.

Value vs. momentum

So, IBM is not being seen by the market currently as a value stock. By default in a binary-view world, that leaves it as a momentum stock. Just one with an unpleasant recent form of momentum. Can that be changing? If it is, should it be pursued?

Figure 3 provides a look at how IBM's market quotes have changed in the 16 weeks (80 market days) following its forecast Range Indexes at various levels. The blue row is the average CAGRs over the past ~five years.

Figure 3

Click to enlarge

Rows above and below the blue average row show the effect of including in their average only those with progressively more extreme RIs. The number of RIs included in each row is indicated by the #BUYS column, and the magenta flag indicates where the current RI is contained.

So Figure 3 describes a poor value stock when its RI is below 40, and a fair momentum prospect when the RI is above 40. The magenta signal suggests that accomplished momentum has not yet made us too late for this game.

But should we want to pursue it? Is the "bell worth the candle?", the reward worth the risk? To get some perspective we can look at the odds for success as a buyer now of IBM, and the prior payoffs, comparing wins against losses. Figure 4 tells what proportion of #BUYS were winners.

Figure 4

Click to enlarge

What this says is that if the RI evolves into a 40+ (perhaps by both rising market quote and a slightly slower increase in expectations) about two-thirds of the time a profit has been had. My reaction: Not highly compelling, but this should be your choice.

What about the size of the payoffs in the two-thirds, compared with the size of the one-third losses? See Figure 5.

Figure 5

Click to enlarge

This takes a bit more understanding. The size of the display format and the detail of the things being measured (containing a decimal point that takes up valuable space) urges us to compel the viewer to mentally insert those decimal points between the two integers shown in each cell of the table. So for RI row >40 and #days column +30, the cell showing 23 should be read 2.3. Its meaning is that the two-thirds winners (60 of 90) had profits 2.3 times as large as the losses experienced by the other 30 of the 90. You decide if these are pleasing or alarming proportions.

We still haven't addressed the "Why now"?

Some investors see in IBM's Watson tool a new direction for the company to pursue as a leading competitive strength in the Information Technology space. We are interested, but claim no skills in the area, only a way to observe the reactions of others.

Some SA contributors see IBM's recent acquisition of Truven Health Analytics as a sign of intensity of its interest in applying Watson to the Medical Diagnostics area, and perhaps further into medical information and practices support.

Since many investors have been known to sell investments in order to further their life expectancy or moderate its continuity, and few have been known to sell body parts in order to buy investments, the economics of that competitive notion seem sound.

Conclusion

Whether Truven's acquisition by IBM is as significant as may be apparent to many remains to be seen. We hope it to be so; the medical and healthcare sectors are areas of rapidly advancing technologies that need supports that may keep costs under better control.

Perhaps the above will provide some perspective on the investing possibilities as they develop.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.