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As the old adage goes, and so does our trading idea (or ex-ante for now). One of the most talked about thing lately has been Mr.Buffets $10 B investment in IBM, and IBM’s 5 year plan of $20/share operating EPS till 2015.Nonetheless,before we delve ourselves into what the idea is all about, its important for us to understand the facts and the suggested commitment.
IBM:
So what is that is offered by IBM ?
a) IBM closed 14th Feb’12 at 192.22.
b) It trades just 2 dollars shy of its 52 week high, and a PE of 14.72.
c) EPS has grown compounded by around 17 % approx over the past 7 years.
d) Plans to have $20/share Operating EPS by 2015 ( if history is any guide, they probably will achieve that target )
b) It trades just 2 dollars shy of its 52 week high, and a PE of 14.72.
c) EPS has grown compounded by around 17 % approx over the past 7 years.
d) Plans to have $20/share Operating EPS by 2015 ( if history is any guide, they probably will achieve that target )
Here is where you can find historical comparison of IBM technicals over time.
That said, we are not fortune tellers here, and we are neither trying to predict what tomorrow would look to be. We are here to look at investments (or trading decisions), based on informed, and intelligent analysis.
Without further wait lets just move onto the present trading idea, and see how at times inefficiencies in the marketplace can help investors capitalize on information and knowledge. Fear is the friend of an intelligent investor, and optimism his worst enemy.
a) The idea is for the fixed income part of the portfolio
b) 2 year BBB rated bonds yield less than 3 % ( That comes along with a lot of risk itself , credit as well as interest rate risk)
c) We think options with Strike ranging from 180-200 on IBM spread out ( or just 190, which is the focus of the analysis here) offers a really attractive return for the amount of money at risk.
b) 2 year BBB rated bonds yield less than 3 % ( That comes along with a lot of risk itself , credit as well as interest rate risk)
c) We think options with Strike ranging from 180-200 on IBM spread out ( or just 190, which is the focus of the analysis here) offers a really attractive return for the amount of money at risk.
Now lets see how it works, and what are the assumptions implicit within the argument for the trade. Assume we select 190 as the strike price for options expiring in 2014, and get paid a premium of around 25. For the same, as we are risk averse we would like to have our accounts fully funded for the maximum net money which we shall ever be required to put which is around ($165). What are the things we can expect after two years ?
Scenario 1 : Options get exercised , and you are made to buy the options at a strike price of 190 two years from now. Even on a conservative basis, if EPS grows by 10 percent, you would be holding one of the blue chip stocks at a PE of around 12 ( at a price of $190), not bad when the lowest it dropped to was around 9 during the financial crisis, so very much limited downside. Even at this price you are still up around $ 25 to the actual money you had to put down 2 years ago.
Your buffer is 165, anything below that eats into capital for a dollar to dollar loss, that said 165 which would your actual cost relates into a PE of 10.5 and not 12 mentioned above, which was the PE at 190 two years from now considering EPS grew compounded at 10 percent. Historic average PE of IBM starting from 1985 is around 15.74.
Scenario 2: Options do not get exercised, in this case you get a return of approx 7.3 percent compounded over a period of 2 years.
As a Fixed Income investor, I think for the risks, the rewards offered by this transaction makes more sense as compared to even High Yield debt, and any other debt investment.
If you have any questions feel free to write us back at info@valueeinvestor.com
