IBM’s performance relative to the S&P 500 Information Technology Index peaked March 2013. In fact, between April 18, 2013 and July 18, 2014, IBM shed 7.1% on an appreciation-only basis, while the sector gained 40.9% excluding dividends. On the heels of this dramatic underperformance, we observe evidence that suggests the sub-par returns that have characterized the last 16 months of price action for Big Blue are likely to improve for the next year or so. We anticipate absolute price gains in shares of IBM and think the stock can lead the Technology sector going forward.

Foremost, we cite the condition of our primary timing indicator, which is a price-based oscillator based on the work of award-winning economist, Edwin S. C. Coppock. Notice in the bottom-most pane of the following chart that monthly momentum appears to have troughed at the end of June, below the zero line. If correct, this observation constitutes a classic Coppock Guide Buy Signal. Such signals tend to coincide with compelling rates of return 11-14 months (or so) forward. In line with the historical norm, our model anticipates that the favorable long-term momentum backdrop should persist through April 2015.

IBM Price Path with Medium and Long-Term Momentum (Data: Thomson Financial, LP)
IBM Price Path with Medium and Long-Term Momentum (Data: Thomson Financial, LP)

Similarly, weekly momentum (shown in the middle pane of the chart) seems to have bottomed last week, suggesting that IBM is as timely over the medium-term as is it over the longer-term. In fact, our models anticipate IBM’s intermediate-degree march to the upside will encounter nothing more severe than short-term weakness through September.

In addition to a constructive momentum climate over the medium and longer term, earnings estimate revisions corroborate the potential for $IBM outperformance going forward.  To support this notion, consider the next chart, from Zacks.com. Over the last seven days, the Wall Street analyst community has upped next quarter earnings estimates at a ratio of 7:1. Similarly, next year earnings estimates have been ratcheted up at a rate of three upgrades for each downgrade.

IBM Earnings Estimate Revisions (Source: Zacks.com)
IBM Earnings Estimate Revisions (Source: Zacks.com)

Earnings estimate revisions have been empirically demonstrated to predict forward equity price performance. To wit, one of the earliest known examinations of this topic occurred in 1969. Burton Fabricand studied I/B/E/S earnings data from the 1965-68 timeframe and concluded that firms that were subject to large upward earnings estimate revisions tended to outperform over the subsequent three month period. Along the same vein, in 1979 Dr. Leonard Zacks demonstrated that  companies whose consensus earnings estimates were too low beat the market, on average, while companies with overly optimistic earnings estimates generally lagged (intuitively, rising estimates should identify those companies whose earnings prowess has been underestimated).

Sentiment/valuation conditions likewise support the prospect of a turnaround for IBM. The bottom pane of the third chart shows IBM’s trailing 12-month (TTM) P/E ratio (in black). The gray lines featured in that bottom pane represent a standard Bollinger Band setup: the middle line shows the 20-period moving average of the trailing 12-month P/E ratio, and the outer gray lines indicate two standard deviations above and below a 20-period average series. The outer gray lines are intended to indicate overbought and oversold, or high and low relative valuation levels.

IBM monthly price and trailing 12-month P/E Ratio (Source Thomson Financial, LP)
IBM monthly price and trailing 12-month P/E Ratio (Source Thomson Financial, LP)

Currently, two standard deviations below the average P/E of the last 20 months is 10.39. IBM’s TTM P/E as of the is time of this writing is 11.34, less than one full turn above the lower bound, and 0.9 points below average. Thus IBM’s valuation is definitely unassuming. More importantly though, momentum for IBM’s TTM P/E bottomed this past February and looks slated to improve into next year, suggesting that multiple expansion is likely in months ahead. Relatedly, momentum for IBM’s implied historical EPS stream (calculated from data from Thomson Financial, LP as IBM’s monthly price per share ÷ monthly TTM P/E) is constructive, but looks stretched. The model hints that absolute earnings might encounter obstacles by before year-end. Taken together, momentum indications for valuation and earnings imply that IBM price gains over the next few months will be powered by the dual engines of an expanding P/E multiple as well as by rising earnings. By Fall/Winter however, multiple expansion will likely more independently underpin forward share price growth for IBM.

In summary, we are debuting here our bullish outlook for shares of $IBM over the next several months and the next year or so. Our outlook is supported by constructive medium and long-term momentum indications, improved near and longer-term earning estimate revisions and a compelling sentiment/valuation backdrop. We are looking for shares to rally into 2015 driven largely by a re-rating of the P/E multiple, but another earnings beat (next quarter) might help also aid IBM’s cause.

Stay tuned!

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