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Trade of the Day: IBM (IBM)

This IT giant is flirting with a crucial technical setup for a long-side entry

   

The Dow has fared quite well, with a performance of 13.8% so far this year — even after giving back 3.3% from May’s highs. And that’s in spite of the volatility spike in everything from stocks to munis to commodities, in spite of the angst over Fed taper timing, and in spite of the fears over the Chinese liquidity crisis and renewed worries coming from the periphery of Europe.

A Dow Laggard

With this kind of historic performance, it is hard to imagine that any of the 30 Dow components would not be contributing their fair share. But there are three companies that bucked the ripping trend and have managed to come out in the red: Alcoa (AA), Caterpillar (CAT), and IBM (IBM). AA and CAT are down 9.6% and 7.3%, respectively, for the first half of the year; IBM, on the other hand finished down 0.2% for the first half of 2013. The stock had been up over 12% year-to-date in March before falling $22 (-10.5%) in three trading days when IBM missed both the top and bottom lines in their quarterly earnings announcement on April 19. Then after climbing back to a 10% gain, it has again fallen by more than $13 since June 18.

While long-term IBM shareholders have undoubtedly been dismayed by this, especially against the backdrop of the Dow’s stellar gains, this back-and-forth action has established a consistent price range for traders. In fact, since reaching an all-time high of $209.50 back in April 2012, the stock has failed to advance appreciably — while at the same time demonstrating that strong buying support exists at prices below $190. Could this technical range offer profitable trading opportunities, or will the recent spate of bad news and negative industry views take its toll on IBM?

Dow Technical Outlook

dow trendline Trade of the Day: IBM (IBM)
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Being the heaviest-weighted stock in the Dow, much of IBM’s prospects depend on the index’s performance from here. The Dow trended along a very consistent channel since its turnaround in November of last year. However, on May 22 it reached an all-time high intraday but closed well down for the session. Over the course of the next few weeks, the index tested the bottom of its trendline but then failed on Ben Bernanke’s comments regarding the Fed’s blueprint for tapering. It has since rallied back to the underside of these trendlines — a common retracement pattern after support has been broken.

Prospects for IBM’s Second Quarter

IBM’s earnings report isn’t until July 17, but it has nevertheless had a difficult string of trading sessions since June 20 as both Oracle (ORCL) and Accenture (ACN) reported disappointing results and guided lower in their key business segments that compete directly with IBM. Many feel that these results may be a harbinger of how IBM’s quarter is shaping up, too. After missing expectations last quarter, another miss could be costly.

ORCL’s software business and ACN’s consulting business are seen as leading indicators for IBM. Software is approximately 25% of IBM’s revenue, but this division’s growth rate fell from 12% year-over-year growth in 2011 to the low single digits last year — and may possibly be negative this year. ORCL’s guidance for growth came in at the very low end of guidance (only 1%) and confirmed that this part of the business is under pressure. Meanwhile, ACN’s consulting business came in with flat growth while the company missed on the overall top-line estimate by $200 million. IBM’s Global Technology and Global Business Services segments — where they compete with ACN — account for 60% of revenue.

For Q1 2013, IBM’s total revenues fell 5% year-over-year, although EPS rose 8%. Analysts are expecting revenue growth of only 1%-2% this year — but EPS growth of 9%. Part of the reason for EPS outperformance is due not only to increased efficiencies or productivity savings, but to the fact that IBM has spent nearly $15 billion buying back its stock over the last six quarters and has taken over 200 million shares from the outstanding count since late 2009.

IBM is not an expensive company. At only 10.4x forward P/E and 10x operating cash flow, the stock is not in danger of serious multiple-contraction if the market sells off. However, its revenue growth (or lack thereof) will be a key issue in determining whether its valuation will expand from here. While share repurchases alone may add 3%-4% to EPS growth, investors are not likely to pay current prices for little to zero revenue growth.

Trading Range or Trend Reversal?

IBM has been in an 18-month trading range between roughly $190 as support and $210 as resistance. Moves above or below these levels have been short-lived, and have tended to reverse with strong pushes to the opposite side of the range. The recent pullback is testing this support level anew and, at least in the short term, the intraday action on Friday, June 28 following ACN’s disappointing results confirmed strong buying support for IBM, which was briefly sold down to $189 but quickly reversed up past $192.

ibm 18 mo Trade of the Day: IBM (IBM)
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Will this provide a good short-term trading opportunity? Yes — but much depends on the immediate reaction to this support level. If you decide to go long here, look for strong “price rejection” on any intraday plumbs down to levels near $189 or lower. If the stock consolidates at the current price with little pop or movement upward, this could signal that buyers are wary and that support is waning in advance of the Q2 announcement.

There is additional risk entering the trade here in advance of IBM’s earnings announcement, especially with negative whispers hanging over it. However, if the announcement or the Dow’s performance takes the stock below support, we could see the beginning of a reversal of IBM’s long-term uptrend since 2009. Failing the support of its current consolidation could see the stock trade down to the next level of support near $160.

Recommendation: IBM is at a key inflexion point, and will likely be leading the Dow. We are more bullish than bearish, but a break below support should not be ignored. We recommend long entries at this $190-$191 level with a minimum target of $210 per share by September. Because sentiment is relatively balanced, we recommend a stop and reverse if the stock breaks below near-term support at $160.

Option Alternative: You can implement the same strategy by buying to open the IBM Sept 195 Calls for $6.00 per share or less. We recommend a stop and reverse on the same conditions outlined above.

InvestorPlace advisors John Jagerson and S. Wade Hansen are co-founders of LearningMarkets.com, as well as the co-editors of SlingShot Trader, a trading service designed to help you make options profits by trading the news.  Get in on the next trade and get 1 free month today by clicking here.


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