Technically, you should buy IBM
We examined the company using Moving Average Convergence-Divergence (MACD), which is one of the most popular and long-used technical analysis indicators. Technical analysis is the field of buying and selling stocks not based on the underlying merits of a company, but rather on the patterns and formulas around its price movements.
Signal line crossover is one of the more common ways to interpret MACD. It uses a series of moving averages (in this case, nine, 12, and 26 days) to look for bullish and bearish crossovers that indicate a stock has momentum in one direction or another. Below you can find a current chart of IBM's MACD profile:
Still, if you'd strictly followed the rules, seeking out upward and downward momentum, you would have seen the stock move between buy and sell categories a fantastic 29 times!
A better way to size up companies
Here at Fool.com we're more interested in other measures of company value. When we look at IBM and its peers, here are the areas that interest us:
Market Cap (millions)
Annual Revenue Growth
Revenue (TTM, millions)
Operating Margin (TTM)
Source: Capital IQ, a division of Standard and Poor's; TTM = trailing 12 months.
We prefer to look at the fundamental drivers of value. Investors should closely watch statistical fields like return on equity as well as qualitative values like competitive advantage and managerial effectiveness. These areas led investors like Warren Buffett and Seth Klarman to decades of outperformance. Buying and holding great companies is the best solution for individual investors to build lasting wealth and achieve their financial goals.
So when you look at IBM, don't evaluate it for crossing a momentum line. Buy or sell it because:
- IBM's management has performed exceptionally over the past decade. Big Blue has transformed itself into a hardware-plus-software-plus-services machine that mints cash at an alarming rate. Thanks to a renewed focus, operating margins have increased 77% since the end of 2004. Also music to shareholders' ears is return on equity, which has increased from 25.2% in 2004 to 76.9% today. Simply put, IBM uses its balance sheet better than any other high-tech giant.
- With its stellar stewardship over the past decade, IBM's management deserves the benefit of the doubt. So when the company lays out a plan to double earnings by 2015, it should get investor's attention. IBM trades at a forward P/E of only 10.5, has been producing cash at stunning rates, and is looking at heady earnings-per-share growth in coming years. That looks like a winning combination for long-term investors.
- The main complaint with IBM is its less than stellar top-line growth. The company has been growing earnings mainly by moving into higher margin areas, buying back stock to produce better earnings per share, cutting costs, and acquisitions. While IBM is extremely adept at integrating bolt-on acquisitions into its services and hardware model, acquisitions, cost cutting, and buying back stock can only go on for so long. At some point, the company needs to produce better revenue by growing its core business.
Want to buy IBM based on technical merits today? Technically, odds are that you should flip and sell IBM sometime very soon. If that sounds like madness to you, well, we here at Fool.com agree. In every market decline, technical analysis gets its share of proponents. The cries that "buy-and-hold is dead!" get louder, and individuals race toward schemes that promise greater wealth in a shorter amount of time.
I don't deny that technical analysis could make investors money. In any random short-term transaction, you're essentially playing a 50/50 game of chance. However, at the same time, most technical analysis schemes are a relatively simple science, eliminating the vast complexities of evaluating true company value. However attractive, this theory is ultimately the wrong path for individual investors. Technical analysis relies on long-held beliefs about exploiting momentum and consistent patterns throughout the market.
However, with as much as 75% of market trading now done by Ph.D-level programmers at massive high-frequency funds, even if opportunities existed, what chance would an individual have to sniff these deals out? With so much volume now driven by these funds, how can you be certain the same rules of patterns still even exist?
I could also point to Massey University's study across 49 countries, which showed that more than 5,000 trading rules add no value. However, the real reason to forget about technical investing is what we mentioned earlier: IBM crossed the crossover 29 times across the past year! While traders might not buy and sell with each crossing, cases of high momentum are normally short lived. The amount of trading in most technical analysis schemes racks up commission fees and short-term capital gains taxes, eating away at profits. More importantly, it takes away from the idea of holding a portfolio of great companies that can accrue wealth over a long time horizon.
That's why, at Fool.com, we recommend that individual investors establish a portfolio of well-managed companies with strong advantages over their competitors. In the end, we find that to be the best contributor to long-term wealth. More importantly, it'll spare you from sitting bleary-eyed in front of a computer with a Big Gulp full of coffee, frantically buying in and out of companies. But hey, if your idea of protecting your future is charting the ups and downs of Moving Average Convergence-Divergence charts, then IBM looks like a buy right now. Just don't expect to hold it for very long.
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Jeremy Phillips owns shares of no companies listed above. Accenture is a Motley Fool Inside Value recommendation. Try any of our Foolish newsletters today, free for 30 days. The Motley Fool has a disclosure policy.