Why Warren Buffett Is Not About To Give Up On IBM

  • Legendary investor Warren Buffett recently told CNBC that he is still actively buying IBM stock.
  • This came as an eye-opening revelation considering IBM has lost 30% of its value over the past three years.
  • What could Buffett possibly see in IBM that keeps him buying?.

International Business Machines Corp. (NYSE:IBM) remains a tech giant caught up deep in the throes of a business model transition. Consequently, IBM stock has lost about 30% of its value over the past three years as investors continue weighing the company's prospects in the face of a revenue tailspin that dates back 16 straight quarters.

IBM stock chart

Source: International Business Machines Corp. stock price chart by amigobulls.com

Despite this unenviable backdrop, IBM has continued to attract the attention of some of the biggest names in investments circles. Notable among them is legendary investor Warren Buffett of Berkshire Hathaway Inc (NYSE:BRK.A) whose love affair with IBM stock is as interesting as it is baffling. Berkshire Hathaway owned an 8.59% stake in IBM by the end of 2015, worth roughly $11.4B, the company's fourth-largest position. Following Berkshire Hathaway's 16th Annual Shareholder Meeting, Mr. Buffett spoke to CNBC in a three-hour breakfast meeting where he talked about his investments in IBM, The Coca Cola Co. (NYSE:KO), and American Express Company (NYSE:AXP), and also spoke about the need for a change at Yahoo (NSDQ:YHOO).

Buffett stated that he is still buying IBM stock though not as aggressively as he has done in the past. He added that his cost basis (the purchase price of the stock adjusted for dividends, stock splits, return of capital distribution) is a little less than $170 per share. Berkshire posted a $2.6B paper loss on IBM by the end of 2015. Although the stock is up 8.23% YTD, the current share price of $148.95 means that Buffett's IBM investment remains deep in the red.

Buffett added that he is still comfortable with IBM's prospects or else he would not own the stock. He also stated that the fact that IBM has tough competition is not unique in any way since many other great companies are in a similar situation. In an earlier annual shareholder missive where he discussed the so-called Big Four (IBM, Coke, American Express, and Wells Fargo) he said one reason why he loves the companies is because they:

"possess excellent businesses and are run by managers who are both talented and shareholder-oriented."

IBM certainly fits the bill as far as being shareholder friendly. Big Blue has purchased more than 40% of outstanding shares over the past decade, making it one the top buyback champs in the tech sector. IBM's massive buybacks have helped its earnings remain fairly constant even as the top line continued contracting. Buybacks have also been partly responsible for Berkshire's growing stake. In fact, IBM's buybacks alone helped increase Berkshire's stake in the company from 7.8% by the end of 2014 to 8.59% by the end of 2015.

On the surface, IBM looks like toast with almost no hope that its core server business will ever recover to its former market dominance. But the company's Strategic Imperatives consisting of Cloud, Analytics, Big Data, Mobile, Social and Security have continued to do well. During the Q1 2016 earnings call, Strategic Imperatives grew 14% Y/Y to $7.0B. This segment now drives 37% of IBM's top line. In comparison, IBM's first quarter revenue of $18.7B was down 5% Y/Y. IBM reported cloud revenue of $2.6B, up 34% Y/Y. The company finished the quarter on a cloud annual revenue run rate of $5.4B, up 42% Y/Y.

Long-Term Investing

So IBM is busy pivoting to Strategic Imperatives as its traditional three-pronged business continues disintegrating. The company has a vaunted history of successfully undergoing business model transitions in the past so maybe this is one of the reasons Buffett loves the company. Meanwhile, IBM stock trades at an absurdly cheap 9.8x trailing earnings.

But this does not mean that IBM is automatically a good buy. Buffett has gone on record acknowledging that his investment in IBM could go awry just as a few of his investments in the past:

"We've owned stocks that we've lost money in, If I'm wrong, you sell them out and take a big loss. We've done that on a few occasions with stocks and bonds over the years."

"What you pay for a stock doesn't mean anything. What means something is where the company's going to be in five to 10 years," Buffett said. "I think IBM will be worth more money but, like I said, I could be wrong but we'll accept that."

It's important to note that IBM's share repurchases, though still impressive, are not as copious as they were in the past. IBM largely slammed the brakes on its share repurchases in 2014 to concentrate more of its investments on Strategic Imperatives and the cloud. Without financial engineering to prop earnings, IBM posted a 17% drop in net income to $2.0B while EPS plunged 14% to $2.09 during the last quarter. If IBM's bottom line continues contracting, then the shares will gradually become more expensive even if the share price remains unchanged.

But with Strategic Imperatives making up 37% of IBM's revenue and growing in double digits, there is a good chance that the company will eventually start growing again. But this is not something that is likely to happen over the next two or even three years given that all other IBM segments including Technology Services, Systems, Global Financing, Global Process Services, and Application Management are all posting revenue declines. Warren Buffett is famous for holding on to stocks for years or even decades, including losing stocks. IBM could turn out to be a good value play but only for investors with an unusually long investment timeframe.

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Comments on this article and IBM stock

user profile picture
alexcho
neutral
Dude, Buffett is spelled with two T's at the end.
1 reply
user profile picture
seamles
bullish
k Alex, thanks for the head up,
1 reply
Do share this awesome post