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Lessons from Warren Buffett's IBM Investment
Posted by: Patrick Goldin
Date: November 30, 2011 12:47PM
rocked the collective value investing boat with his surprise revelation on CNBC’s Squawk Box of a 5.5% stake in International Business Machines (IBM
), better known as IBM.
To say this surprised even the most avid Buffett watchers is an understatement, as IBM epitomizes information technology. In fact, one could make the case that the aversion to technology companies generally by many value investors is inspired solely by Warren Buffett
’s well know distaste for this section of the market. So what can we learn from this investment? Through the extensive discussion on IBM that followed the announcement, I have identified four key lessons for investors of all stripes.
Lesson #1: Worry About Price in Relation to Value, Not the Trading Range. IBM has now gained nearly 25% for the year, compare with a flat Down Jones Industrial Average. With that rise, the share price now sits near its all time high of $190. Admittedly, Berkshire Hathaway’s (BRK.A)(BRK.B) average cost is $170, but even that is only a slim discount. This alone would put off many value investors, myself included, but obviously not Warren. Value investing is not just about buying beaten down, out-of-favor, and neglected companies, but about buying value where ever it can be found. The investor should not worry where a company stands in its trading range or even its performance compared with competitors or indices. Basically, value is value in any form.
Lesson #2: You Don’t Need to Talk to Management. Of course, few investors have access to the management team of a company like IBM, but Warren Buffett didn’t even take the time to inform the company of his ownership stake before the CNBC interview. His due diligence process consisted of SEC filings, scuttlebutt data, and "Who Says Elephants Can’t Dance?," the memoir of Louis Gerstner, who is credited with pulling IBM out of the ditch. The small investor should not feel that he or she has an inherent disadvantage due to their inability to to speak with management as a part of their due diligence process.
Lesson #3: Be Intellectually Flexible. In his CNBC interview, Warren stated that when he read through the company’s most recent annual report, something clicked in his head, which after 50 years of following IBM, interested him in buying a stake. He is open to adjusting his views to accommodate new information and new ideas. Apparently, even after 50 years, he is still not content to finally accept their infallibility. Charlie Munger himself has marveled at the fact that Warren Buffett is a "learning machine."
Lesson #4: Technology Avoidance Is a Misnomer. Warren Buffett’s lack of investments in the technology arena is highly publicized. During the technology bubble, he was widely castigated by the financial press for his lack of "understanding" of a new paradigm. Yet, his circle of competence remained consistent and eventually, he had the last laugh when many technology issues crashed back to earth. While not widely publicized, Warren purchased Amazon bonds at distressed prices in the wake of the dot-com collapse. His investment paid off handsomely when the bonds where paid off at par. Warren was even the chairman of Mid-Continent Tabulating Company. Before computer were digital, they received instructions from Marke-Sense Cards, better known as punch or tab cards.
These anecdotes aside, technology is a very broad sector of the marketplace. Different companies’ results possess different drivers, from defense s pending to corporate IT department budgets. But what investors most closely associate with technology are those driven by consumer preferences: Apple, Netflix, Facebook, etc. The recent ascensions and subsequent plunges in the value of Research In Motion, MySpace, and Motorola demonstrate the fact that their market dominance lasted only as long as they remained on top of the product cycle. This cycle is driven by consumer preferences that are prone to change at a moment’s notice. Accurately predicting the earning power over the long-term of consumer technology firms is extremely difficult if not impossible. This is why Berkshire Hathaway has avoided this segment.
Corporate technology is different. Product life cycles are longer and IT departments exhibit "brand loyalty" due to the switching costs required. Not only is it expensive, but also requires time and effort. Thus, the corporate side had more continuity than the consumer business, which makes it more possible to evaluate the longer-term economics.
But has Warren really even disregarded technology companies in the past? The examples highlighted earlier dispel this idea. In addition, during the course of the interview, Warren addressed the question directly with: "I look at everything but most things I decide I can’t figure out their economic future"
Even today, Warren Buffett
continues to shock the marketplace with decisions that oppose his previous actions. He would only buy asset-light businesses requiring minimal capital expenditures. Then he purchased utilities and a major railroad. He would not issue shares to fund acquisitions or do share buybacks. Then he issued shares to Burlington Northern shareholders and announced a share buyback program. He would not buy common shares of a technology company. Now one of the world’s most highly recognized providers of technology products and services sits as one of his largest holdings. Warren does not pigeonhole himself based upon his past course of actions. He will take a different tack based solely upon the prevailing market winds. This is what has made Warren Buffett
the greatest investor of our time.
Stocks Discussed: IBM