Why It May Be Time to Take Some Profits on IBM Stock

At the end of August 2019, in a column on InvestorPlace.com, I laid out three main reasons why it was time to buy the dip in International Business Machines (NYSE:IBM) stock at $130.

Those three reasons were very simple. One, at $130, IBM stock was attractively undervalued relative to its long-term growth potential. Two, the outlook of IBM stock was improving, due to its rebounding growth trends. Three, the technicals of IBM stock indicated that it was oversold, and implied that the stock was due for a bounce.

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Fast forward a little over a month. IBM stock has risen about 8% since then. The S&P 500 has been flat over that same stretch. That was a sizable outperformance by IBM stock in a relatively short period of time. As a result, I think it may be time for investors  to rethink  their strategy on IBM stock.

Anyone who does that will see that the bull thesis on IBM stock has lost some luster.

First, the valuation of International Business Machines stock now seems fair and it looks unlikely to rise much in the near-term. Second, its outlook is still poised to improve, but IBM stock price now arguably accounts for that. Third, the stock is no longer in oversold territory and its technicals look mixed, not bullish.

As a result, it may be time to do some profit-taking on IBM stock. While the shares don’t look bad now, they also don’t look all that compelling. Considering the poor macro backdrop, it’s not a good idea to hold onto a stock simply because “it doesn’t look bad.”  That’s why I recommend selling IBM stock at this point.

Valuation No Longer Cheap

The valuation underlying IBM stock is no longer discounted like it was a month ago.

IBM has been a no-growth company for a long time, and its margins have been pressured. This combination has ultimately depressed the company’s profit growth.

That should all change going forward for two major reasons. First, IBM’s growing cloud businesses is becoming bigger, while its eroding legacy business is becoming smaller. Over time, its cloud business will start to be the main driver of its results,

Second, IBM’s acquisition of rapidly growing, high-margin hybrid cloud player Red Hat should supercharge its revenue growth over the next several years, while also boosting its margins.

So IBM should turn into a low-growth company over the next few years with positive catalysts that should increase its margins.

Consequently, IBM’s earnings per share look poised to hit $16-$16.50 by fiscal 2025. Taking the midpoint of that EPS range and applying a forward earnings multiple of 12 to it results in a 2024 price target for IBM stock of $195.  When the company’s profits were rising a few years back, its forward P/E ratio was 12.

Discounted back by 6% per year (four percentage points below my customary 10% discount rate to account for the 4% yield of International Business Machines stock),  that implies a 2019 price target of about $145. Thus, while IBM stock still trades at a discount to that 2019 price target, the discount is much smaller today (3.5%) than it was a month ago (10.3%).

The Outlook of IBM Stock Is  Still Improving

The outlook of IBM stock is still set to meaningfully improve over the next few quarters, and that should provide solid support for the stock.

That is, IBM is in the early innings of going from a no-growth company with margin pressures to a low-growth company with positive margin catalysts.

According to data from YCharts, Wall Street, on average, is modeling for negative revenue growth this quarter, nearly 2% revenue growth next quarter, about 4% revenue growth next year, and nearly 2% revenue growth the following year. At the same time, IBM’s EBITDA margins are expected to expand almost two percentage points from fiscal 2019 to fiscal 2021, powering 5% EPS growth in FY20 and 7% EPS growth in FY21.

Investors will want to buy IBM stock ahead of its growth acceleration in FY20 and FY21. But one could also reasonably argue that – since the stock is trading near its fair value – the shares already reflect the company’s improved growth outlook.

The Technicals of IBM Stock Are No Longer Bullish

The technicals underlying IBM stock were very bullish a month ago. The stock had dropped into technically oversold territory, defined by a historically low Relative Strength Index reading. History has shown that such drops into technically oversold territory have almost always been followed by strong rebound rallies.

That rebound has now fully played out.

IBM stock is no longer in technically oversold territory. Instead, its Relative Strength Index sits in perfectly neutral territory at roughly 50. Further, the stock appears to be running into some technical resistance in the mid-$140s, an  area which has provided technical resistance before.

On the technical side of things, then, most of the near-term rally of IBM appears to have already happened.

The Bottom Line on International Business Machines Stock

IBM stock looked good at $130 when it was on the heels of a big selloff. Now, with IBM stock price above $140 and on the heels of a big rally, the shares don’t look so great. As a result, investors who bought the shares on weakness at $130 may want to take this opportunity to do some profit-taking at $140.

As of this writing, Luke Lango did not hold a position in any of the aforementioned securities. 

Article printed from InvestorPlace Media, https://investorplace.com/2019/10/why-it-may-be-time-to-take-some-profits-on-ibm-stock/.

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