IBM Investment- Since April of this year, we have been running a real-time case study related to incorporating option positions into the holdings of an investment portfolio of a positional, value-based investor. As a subject for our case, we used the quintessential “Old Tech” company — IBM — and walked through our thoughts on valuing the company, using options to enter a position, and managing option assignment and expiration (You can find all of the articles in the IBM Case Study here: Entering and Managing an Option Investment, Options Offer More Options, Fact-Based Valuation, Applying the Scientific Method to Investing, Managing an Option Investment, Option Assignment, Option Expiration).
The market gods have not been with us in this investment, however, and the stock is now trading for about 13% less than our Effective Buy Price in the $147 / share range.
While not thrilled to be holding a position with an unrealized loss, this is the essence of risk in the capital markets — not everything one buys as an investment increases in value right away, and some stocks decrease for awhile before they increase.
As you can see from the figure above, the stock price recently took a series of pretty hefty hits. The first of those was just IBM being dragged down by general market weakness. The more recent of those represents the market reaction to the company’s most recent quarterly earnings announcement.
Whether an investor uses options to effect an investment strategy or not, the most important determinant of ultimate investment success revolves around the relationship between the price at which the investor buys and the underlying value of the company. As such, my first reaction upon seeing the drop in IBM’s stock price was to look through the earnings announcement and decide whether the news changed my view of the company. I published an article to Framework members with my findings, and will summarize what I found here.
As I explain in my article entitled Fact-Based Valuation, there are only a few things that can influence the intrinsic value of a company, and those things all revolve around the process of generating cash flows. We focus in on Revenue Growth, Profitability, Investment Spending, and likely Future Growth based on the projects in which the company is investing. Most commentators talked a lot about IBM’s revenues and were disappointed with the flat (adjusted for foreign currency movements) or slightly down (nominal) change in quarterly sales.