IBM is being touted as a good defensive technology stock these days. They pay a very good dividend and isn’t as volatile as many tech stocks. Does this make it a good defensive play?
Given that a lot of investors are at least a little skittish about the risk that holding stocks involved, and given that they still want to be in the stock market but may be made more comfortable by their reducing their risk, the idea of a more defensive stock may indeed be seen as appealing.
If we do want to go down this road, it is at least important to look to gain a little better idea of what we are doing instead of just swallowing some of the ideas out there whole. This is especially important given that the public really doesn’t question investing ideas all that much, where just taking a step back and thinking about these things a little more can so easily expose their faults.
As far as looking at whether IBM would be a good defensive play, as it is claimed to be, we’re going to have to ask a few questions, starting with why we might want to consider defensive plays instead of other approaches that may achieve the same goals. This will also bring out what we need to be looking for to define a good defensive play, including looking at the pros and cons.
From there, presuming that we decide we want in on this and it suits our needs, we can look at potential candidates, and in this article, we’ll be looking at IBM to not only see if it fits the bill but is attractive enough overall to deliver what we want from this without paying too big of a price to get it.
The goal here is to both decide whether IBM is suitable for this as well as to seek to understand these things better, so we can better ensure that this so-called defensive investing is really right for us, as well as deciding whether a certain stock like IBM does provide real benefits to us overall.
What we tend to do instead is to just jump on plays, and it doesn’t take very much to bait us in this case. They ring the bell, they describe the taste of it, and you salivate. Quite a few people only need to hear things like this stock doesn’t go down as much as other tech stocks tend to, and it pays a very good dividend which will offset your capital losses, and our mouths start to water. Our brain needs to play a role in this as well though.
This certainly may seem like a good idea on the face of it, but we need to always look to go beyond appearances and be willing to look a little deeper, which is exactly what we’ll be doing here. In the end, if the play still makes sense, at least we have vetted it a little, and given that our money is on the line here, we owe it to ourselves to at least be curious.
When we read how keen some people are on recommending this particular stock for defensive purposes, that certainly piqued our curiosity, as this had us wondering how much these people really know about what makes a good defensive stock. The qualities that are serving as the bait certainly are not enough, as we need to look at the whole package and not just a couple of features to decide this if we’re supposed to put our money on the line.
Our journey needs to start with the way the term is understood generally, and this is where the trouble starts. We use the term defensive pretty loosely here, where instead of referring to a stock that by its nature sees our risk being reduced, like a low beta stock would, it turns out that defensive here just means collecting a stable dividend regardless of how the stock or the market may move.
At best, we could call this a defensive feature of a stock, and when viewed in isolation, it could be seen as a plus, but these things never occur in isolation and we need to look at both the entirety of defensive considerations as well as how these considerations fit into the overall picture of the desirability of the play.
IBM fits this definition of a defensive play pretty well indeed, for what that’s worth, and we will have to seek to get a sense of what this is actually worth to be able to decide. It is simply amazing how low the threshold is for a lot of investors where they can see a number like the 4.5% yield that you get with IBM stock buying it here and the hands go up right away to be counted in.
This isn’t just about yield though, what people are looking for is dividend stability, and this is where the defensive idea comes from. You need both to get called this though, both a bigger and a more stable dividend, and IBM scores very well on both counts.
Just taking a quick look at how their dividend payments have played out over the last few years will make this clear.
Back in 2008 they bumped up their dividend from 40 cents a quarter to 50 cents, when the stock was trading at $116 a share. In 2009, this got raised to 55 cents a share even though the stock price dropped to $100. 2010 saw this get bumped up to 65 cents at $129. 2011 got us 75 cents with the price rising to $170.
2012 saw the quarterly dividend to rise to 85 cents and the stock make it to $200. In 2013 we reached a peak stock price of $215 and the dividend moved forward to 95 cents. The stock fell over the next 3 years all the way to $118, and while this was a terrible time to be holding this, this alleged defense just kept being ramped up, and when your stock loses almost half its value, this is the time to see how serious they are about these dividends.
Over this time, it got increased to $1.10 in 2014, $1.30 in 2015, and $1.40 in 2016. The stock has recovered a bit in the almost 4 years since, although we have only gotten back about $20 of the $100 lost, but the dividend has kept rising and is now up to $1.62 a quarter.
How These Dividend Payments Have Fit into the Whole Picture
This is defense personified according to the popular definition, and we definitely tip our hat to IBM for their strong commitment to this. However, we also need to ask how this all fits into the overall picture, and especially how much actual defense is being played here.
The defensive component of this is that this serves to offset capital losses, and there’s been plenty of opportunity for this over the last few years. IBM stock has lost 34% over the last 6 years, dropping $73 a share, but we want to account for the dividend as well, the defensive part.
We get a total of $36 in dividends over this time, which does help offset the loss of $73, but being left with a total net loss of $37 over the last 6 years, at a time where the market has done very well, should not provide much consolation.
In comparison, the Nasdaq has grown by 145% over this time, where our $215 investment would have provided a profit of $312 instead of losing $37, which should in itself have us wondering whether it is worth it to play defense at all, even though this idea has sure cost us a lot of money.
To be fairer, we’ll compare this with a stock that we featured as a good defensive play recently, Coca-Cola. Coke is up a modest 37% over this time, but only had a maximum drawdown of 13%, compared to 49% with IBM. The dividend payments over this time have added up to 22%, for a total return of 59%, a whole lot better than the net loss of 17% that IBM has stuck us with.
This fits the needs of the defensive investor much better of course. IBM is actually a horrible fit here, even though both IBM and Coca-Cola have increased their dividends consistently over this period. Coke does have the things that we need to look for, which first and foremost is net drawdown, because the need here needs to be to want to avoid such things for whatever reason, whether that be because our investment horizon is shorter and we don’t want to get stuck selling at a loss or just because we’re made happier by this and are willing to sacrifice returns to be more comfortable.
It also helps if your stock goes up rather than down, and we need to be particularly alarmed when our alleged defensive play doesn’t even play good defense during bull markets. We can also look at the last 3 years to see this strategy sputter as well, where IBM is down 22% and $40 a share, with a net loss of $21 or 12% over this time. That’s not good defense, it’s absolutely terrible defense.
Coke is up 42% over this time, with the dividend kicking in another 10%, for a total return of 52%. IBM had a maximum drawdown from peak to valley of 39%, while Coke’s was only 12%. These are not two good defensive plays, one of them has been a good one while the other has been anything but. Dividend stability will only take you so far and is not a good in itself, and it surely isn’t one in this case.
We cannot forget that the point of this needs to be to make money first and foremost, and when we use dividends to create a false sense of security, things can get pretty ugly, as we see clearly with this example.
The defensive component cannot just be described by dividend stability, we need to instead look at what we are trying to achieve by looking for stocks that play defense, which is risk reduction. There is no other candidate here. This is why drawdown is the real criteria here because nothing else measures this. If we are worried that our stocks will go down in price, we need to look at how much they do go down to decide this, not just be blinded by dividends and not even look at what we’re supposed to be looking at.
IBM Flunks on All Counts That Matter
IBM is simply slayed by Coca-Cola in this comparison, although the very idea of a defensive technology stock is almost a contradiction in terms. IBM demonstrates this contradiction quite well indeed.
If IBM ever becomes a good stock again, it won’t be because it is defensive, because it simply isn’t and this a real sore point with it actually, and in fact we are going to need more than average upside to justify the greater risk involved. When we do, then it is going to have to be able to stand alongside alternatives, stocks that present similar higher risks but have high enough overall returns to justify it.
IBM definitely has not measured up here in this category, and we only have to look to the Nasdaq to see how badly this stock gets beaten in this arena, and this is an even uglier story than the one with Coke. It might be a technology stock, but it is a crusty one, the crustiest perhaps. All these dividend payments have their price, and the price here is that this limits growth, so they don’t even stand a chance against companies who go all out to jack their stock price and end up with much higher net returns.
If you’re going to need to measure up as a growth stock and your company isn’t really growing, and you’re up against companies growing by leaps and bounds, this is not even a fair fight. AMD is up over 400% over the last 3 years, without paying out any dividends, and this stands particularly tall when you compare IBM’s net loss of 12% after all these dividends are factored in.
AMD’s maximum drawdown over the past 3 years has been 48%, and while that is 9% higher than IBM, we need to look at this dynamically as well. AMD suffered theirs after a 240% run up over a 5-month period in 2018 leading up to this correction, and the stock was still worth double what it was after both the rise and fall played out, and has added 300% more since, where IBM is still below water three years later as a result of their drawdown.
AMD’s risk is therefore actually much lower overall than IBM’s, because the risk here isn’t just a matter of going down, it is much more about staying down. While AMD is an elite growth stock, IBM cannot even hang with the S&P 500 in this regard, with half the drawdown of IBM over this period, its quick recovery from it, and its impressive march forward from there.
IBM simply looks ugly on all fronts, and the only reason people would be holding this would be out of pure ignorance. Not only does it play defense terribly, it is even worse on offense. We need to look at how the two fit together to come to the right decision, or even be in the neighborhood.
While we do need to account for our particular needs and preferences in deciding what mix of offense and defense suits us, but in doing this, we cannot look at either in isolation. Nothing is more defensive than cash, but without an offense at all, this will prevent any more than nominal gains. Bitcoin has an extremely good offense, but completely lacks defense, to the point of being very unsuitable for all but the most skilled of traders who know how to manage this huge risk acceptably.
AMD doesn’t play very good defense, but has such a powerful offense that this only needs to matter to those who won’t be holding it through the peaks and valleys and have a particular need to play better defense. This is comparable to a football team that gives up 7 more points per game than the average but scores 30 more, and while you might be down at any given time, if you can stay in for the whole game, which we should want to as investors, this has you winning big.
IBM is just a bad team that both gives up too many points and scores way too few. Picking such a sad sack team assures you that none of your objectives will be achieved, whatever they happen to be, unless you only care about a certain statistic like how many field goals you score and ignore everything else, including the final result of the game.
Coca-Cola offers a more balanced game for those who need it, playing great defense and also having an offense that can’t compare with the big teams but isn’t that below average. If defense is what we want though, we can’t just look at dividend stability and proclaim that as a good thing and even defensive enough without even peeking at anything else.
For the sake of further comparison, the gold standard for defensive plays is the SPDR utilities index, which offers a more diversified approach to just picking individual stocks if this is what you seek, and it’s 14% maximum drawdown over the last 3 years demonstrates that this does play good defense indeed. It has returned 40% over this period plus an extra 11% from the dividends, for a total return of 51%, so it does play decent offense as well and offers a very nice mix for more defensive investors.
This is a very easy way to invest if this is what you want, and completely shames IBM on both the defensive and offensive side of the ball. It is up 5% in 2020 so far as it continues to make all-time highs and its growth since the start of 2019 has been comparable to the S&P 500, with both beating IBM over this time by over 10%, a period that also featured IBM’s best performance in quite a while.
It is understandable that defensive minded investors may want to avoid growth stocks or even the broad-based S&P 500, and they probably won’t do well finding good defensive stocks on their own since so few even know what they are supposed to be looking for. However just about everyone knows that utility stocks are defensive and when a so-called defensive pick gets shown up this badly by the benchmark, and we’re supposed to want this, this is not defensive, it is clueless.
Picking good stocks isn’t as complicated as many believe, but it’s a little more complicated than just looking at dividends. Simple is good, simple minded is not.