- IBM has performed poorly over the last five years and could report another decline in revenues in 2016.
- Yet Warren Buffett, who owns 8.5% of the company, has no plan of selling IBM stock.
- The company is a cash flow generation machine and could post a turnaround in the near future.
IBM (NYSE:IBM), one of the world’s leading technology company, has taken a lot of flak from Mr. Market due to its shrinking top line. In 2011, the company reported revenues of almost $107 billion, but it has gradually dropped to $81.74 billion last year and could head lower in 2016. As per consensus data from Thomson Reuters, analysts are expecting revenues of $79.5 billion for 2016. That would mark the fifth consecutive decline in annual revenues, pushing them to their lowest level in more than a decade.
Moreover, IBM stock has also gone nowhere over the last five years. As I write this, the shares of the New York-based company are hovering near $162 a piece. Five years ago, in mid-August 2011, IBM stock was trading hands around $165. During this period, the Dow Jones rose 70%, S&P-500 gained 90%, S&P-500’s IT companies rose 120% and Nasdaq-100 climbed 121%. In short, IBM has vastly under-performed when compared against these major indices.
Yet the Big Blue remains one of Warren Buffett’s favorite companies. The Oracle of Omaha’s Berkshire Hathaway Inc (NYSE:BRK.A) (NYSE:BRK.B) has recently released its quarterly results in which the company acknowledged that the poor performance of IBM stock has weighed on its stock portfolio. But Buffett also made it clear that he has no intention of selling IBM stock. The technology company is one of Buffett’s largest investments, representing 9.6% of Berkshire Hathaway’s stock portfolio. Buffett started buying IBM stock in mid-2011 and gradually, through numerous purchases, ended up owning 8.5% of the company which made Berkshire Hathaway its largest institutional investor.
Cash flow machine
Buffett’s confidence in IBM, despite the technology giant’s woes, stems from the company’s ability to generate strong levels of cash flows. IBM’s business, particularly the hardware side, has been weak which has damaged its top-line, but the impact on cash flows hasn’t been significant. The company’s trailing twelve months (TTM) revenues of $80.26 billion are down almost 25% from $106.9 billion in 2011. But IBM has generated $18.6 billion in operating cash flows on a TTM basis, which shows a drop of just 6.3% from $19.85 billion in 2011.
Due to the resilience of cash flows, IBM has been able to consistently self-fund its capital spending for the last several years, which leads to positive free cash flows. In fact, IBM has been reporting free cash flows of more than $10 billion, every year for the last ten years. That’s a remarkable track record which very few companies can match. IBM has used this excess cash to reward shareholders, including Warren Buffett, with dividends.
As indicated earlier, IBM investors have not witnessed any capital appreciation over the last five years, but that doesn’t mean they haven’t seen any gains. During this period, each IBM shareholder has collected $20.45 per share in dividends. If, for instance, an investor bet $10,000 on IBM five years ago, they would have purchased almost 61 shares. That investment would be worth almost $9,900 today, but this does not include total dividends of $1,247 received. Including those, the investor would have seen gains of almost 11.5%. Granted 11.5% return over five years is nothing to be cheerful about, but it’s still considerably better than what you would observe if you look solely at IBM stock.
This also shows that IBM is a high-quality dividend paying company that can reward investors with payouts, even when it struggles with declining revenues. But more importantly, IBM could be on the verge of a turnaround. The company has been undergoing a major transformation by cutting back on some of its key legacy businesses that have little growth potential, such as hardware, and investing heavily in what it calls the “strategic imperatives” segment, which includes areas which offer attractive future growth prospects, such as cloud, analytics and mobile technologies. The company has been posting strong growth in these areas, especially cloud where it posted 30% increase in revenues in the previous quarter. Overall, the strategic imperatives growth clocked in at a decent 12%.
The transformation, however, is a lengthy process, which is why IBM’s total revenues continue to decline, despite double-digit growth in strategic imperatives. But IBM continues to push its strategic imperatives business in the market, which is evident from the recently signed agreement between IBM and Workday (NYSE:WDAY), a leading cloud-powered HR and finance services provider, under which the latter will use the former’s data centers for its applications. Although the pricing of the deal remains undisclosed, we can safely assume that it will fuel the growth of IBM Cloud and further expand its foothold in the market. Over the next few years, perhaps by as early as 2018 when IBM aims to get $40 billion of revenue from the new segment, the increase in strategic imperatives revenues could completely offset the decline in other areas. As a result, its total revenues might grow, which will mark IBM’s turnaround.
Over the last five years, IBM stock has performed poorly and its revenues have been declining. But it remains one of Warren Buffett’s favorite picks, likely due to the company’s ability to generate strong levels of free cash flows. That has allowed IBM to reward shareholders with dividends. Moreover, by focusing on strategic imperatives, the company could turnaround in the next couple of years. If it does, then it will likely reward shareholders with even better levels of dividends.
I believe this could be a good opportunity for long-term investors to buy IBM stock. Its shares are currently attractively priced, with a P/E ratio of 13.2. This compares against S&P-500 average of 20 and the industry’s average of 21.9. The company is also cheap when compared with some of the other technology giants, such as Microsoft (NASDAQ:MSFT) and Intel (NASDAQ:INTC). On top of this, IBM offers an attractive yield of almost 3.5%, considerably higher than the industry’s average of 1.8%.