IBM: Market Expectations Are Way Too Low

| About: International Business (IBM)
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I analyzed the returns of IBM after each quarter's earnings reports.

The results meshed with my previous study, suggesting a profitable investing and trading strategy for IBM.

The strategy is superior to the buy-and-hold strategy yet can also be used by the buy-and-hold investor looking to add more to his/her position.

In my last article on International Business Machines (NYSE:IBM), I recommended buying IBM after Christmas due to a clear seasonal pattern with its Q4 earnings. The pattern is shown below:

After writing that article, I received several follow-up questions. They primarily inquired into a buying or trading strategy based on IBM earnings. Here are a couple such questions:

What do you think of the idea of writing options against IBM prior to earnings?

Thanks for the analysis. You suggest buying IBM prior to earnings. Can you tell us how the IBM stock price has done following earnings over the last 3 years?

Another person mentions shorting IBM prior to earnings, the opposite of what my study suggested:

Shorting IBM into earnings announcements has been a risk free way to make money over the last few years as Ginni keeps stumbling along.

I intend to answer all these questions in this article.

Earnings-based Buying/Shorting

You don't have to be a trader to use earnings in your investment strategy. A stock's seasonality can help you determine when to place your dollar cost averaging buys, for example. They can also help you find exit positions to avoid the opportunity cost of being locked in a dividend stock (e.g., IBM) when similar stocks are paying higher yields.

I'm not going to concern myself with your individual investment strategy here. I hope to merely point out how IBM reacts to earnings each quarter. Though one reader requested I look back 3 years, I'd prefer a larger sample size and am therefore looking back to 2010 for this analysis.

The analysis will look at the returns of the following four results:

  1. Buying IBM before Q1 earnings
  2. Buying IBM before Q2 earnings
  3. Buying IBM before Q3 earnings
  4. Buying IBM before Q4 earnings

The idea is to look at how buying before earnings and holding for a month will compare to holding cash. Let's see how these strategies do:

The Results

Buying IBM before Q1 earnings:

Loss of 12% of your cash.

Buying IBM before Q2 earnings:

Loss of 21% of your cash.

Buying IBM before Q3 earnings:

Essentially the same as cash: Loss of 1% of your cash.

Buying IBM before Q4 earnings:

Gain of 19%.

Implications for Investors and Traders

Both the reader who said "Shorting IBM into earnings announcements has been a risk free way to make money over the last few years" and I were right. Indeed, shorting IBM into Q1 and Q2 earnings was a winning strategy over the past 6 years. But at the same time, going long on IBM before Q4 - as stated in my previous article - is a profitable strategy. For traders, the strategy is clear: short before Q1 and Q2; long before Q4.

For investors, the implications are a bit more complicated. Clearly, my suggestion of placing your dollar cost averaging investment strategy on IBM before Q4 earnings is still a good idea. But what do investors do about Q1 and Q2 earnings reports?

They could just hold on, knowing that the stock will drop but avoiding the taxes, commissions, and possible loss of dividend associated with selling the stock. I know many investors dislike "timing the market" and will stubbornly cling to such a strategy, even if it doesn't make financial sense. For the rest of you, consider simply avoiding two months of the year in IBM, placing your money elsewhere for those two months.

Here is an example of this strategy, placing your money in cash instead of IBM during the two months that surround the Q1 and Q2 earnings reports. The strategy is compared to the buy-and-hold strategy:

The results, particularly effective since 2014, would have resulted in a 65% ROI over the past 6 years, compared to the 14% that IBM has brought investors using the buy-and-hold strategy. In addition, we have a Cagr of 8.62 versus the 2.2 of the buy and hold strategy. The Sharpe ratio of this strategy is triple that of buy-and-hold.

As for risk, we naturally have less volatility exposure because we are staying out of the market two months in the year. But more importantly, we reduce the max drawdown and lower our average drawdown by 35% and 25%, respectively.

What about Options?

As for the options writing question, clearly you'll want to write calls for Q1 and Q2 earnings season and write puts for Q4 earnings season. However, I would never recommend writing calls, as you expose yourself to unlimited risk by doing so. Instead, consider bear credit spreads.

Specific Trading and Investing Strategies

Investors who cannot give up the buy-and-hold strategy should at least place their rebuying plans and dollar cost averaging strategies before Q4 earnings are released. Instead of having your dividends reinvested in IBM at the time of receipt, you should save them to buy before Q4. The dividends can be placed in bonds until the time of purchase.

More open-minded investors should follow the strategy I outlined above: staying out of IBM the months surrounding Q1 and Q2 earnings reports. Specifically, Sell in April and buy back in May; sell in July and buy back in August.

Traders can short IBM into Q1 and Q2 earnings; long into Q4 earnings. Options would be useful here, buying puts or writing calls (not recommended) before Q1 and Q2 earnings; buying calls or writing puts before Q4 earnings.

As January 19 approaches, let's get greedy.

  • Investors: Time to add to your portfolio
  • Traders: Time to long delta or theta; specific trades follow:

Long theta:

  1. Sell Feb 115 puts

Long delta, hedged theta:

  1. Buy Jul 145 Call
  2. Sell Jul 155 Call

Long delta:

  1. Buy Mar 145 Call

Request a Statistical Study

If you would like for me to run a statistical study on a specific aspect of a specific stock, commodity, or market, just request so in the comments section below. Alternatively, send me a message or email.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in IBM over 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.