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Normally, I'm quite a stickler when it comes to understanding the mechanics of a business down to its core genetics, often happy to pay a higher price for something I understand well, rather than a lower price for something that I don't. Such a policy is the best way for an investor to seek value yet avoid getting caught in a value trap, and to easily find the gumption to hold, or buy more, when times get tough.
IBM is in a separate category. It would be nice if I could provide more expertise on the business itself, although it's not like the executives are hiding anything, it's that the specific technological arena that they work in goes a bit outside of my circle of competence. However, for this particular situation, the value is strong enough, and they have enough things weighing on their side, that this cardinal rule for investing is getting placed on a temporary reprieve.
The Known
In reading Buffett's most recent shareholder letter, he sure seems excited about them. This is particularly interesting coming from someone who has spent an entire lifetime avoiding technology. Perhaps, after 50 years of reading IBM's annual reports like he has, I would be able to see what Buffett is seeing in them. However, I have read a few times through about as many years in Buffett letters, and I can see that he is on to something if he is willing to take a 5.6% ownership stake in a more than $200 billion dollar company, making up what is now more than 15% of the Berkshire Hathaway (BRK.A)(BRK.B) portfolio. This is a big pill for even Buffett to swallow. At the very least, we can rest assured that IBM's low valuation is not a value trap. This would have been my concern seeing IBM selling at such a low price. Jumping onto Buffett's investment bandwagon is cheating a bit, but let's take a look at the value anyway.
IBM's net income has been increasing steadily at about 12% per year:
Year Net Income (in billions)
2011 15.86
2010 14.83
2009 13.43
2008 12.33
2007 10.42
2006 9.42
2005 7.99
2004 7.50
2003 6.59
2002 5.33
While considerable shares are being bought with cash generated:
Year Shares Outstanding (in billions)
2011 1.16
2010 1.23
2009 1.31
2008 1.34
2007 1.39
2006 1.51
2005 1.57
2004 1.65
2003 1.69
2002 1.72
Causing earnings/share for IBM to increase by leaps and bounds for a company their size, through both thick and thin, at a rate of about 17%.
Year EPS
2011 13.06
2010 11.52
2009 10.01
2008 8.89
2007 7.15
2006 6.06
2005 4.91
2004 4.39
2003 3.75
2002 3.07
All while their current price is on the low side compared to earnings.
Year Average PE
2011 13.1
2010 11.4
2009 10.9
2008 12.4
2007 14.8
2006 13.7
2005 17
2004 20.7
2003 22.7
2002 27.5
With a little bonus of having regular dividend increases.
Year Dividends/Share
2011 2.90
2010 2.60
2009 2.15
2008 1.90
2007 1.50
2006 1.10
2005 .78
2004 .70
2003 .63
2002 .59
Back to Price Earnings Growth Ratio (PEGR) again...
PEGR = PE / (Growth Rate + Div Yld) = 13.74 / (17 + 1.84) = .73 = A very strong value purchase
A company with a value this strong is screaming for investment, and Buffett sure is answering the call. I also have a special place in my heart for companies who sailed through the previous economic downturn as if nothing had happened. These would generally be the best companies to own now as we are not (officially) in a recession yet. One should be careful not to buy into a company where the tide is likely to be later taken out from under him. Economic downturns are different from each other, and the IBM business model has been evolving over the years. This leaves us in the dark in having multiple comparisons for judging how they might perform through future economic slumps, so it will be interesting to watch if they perform so well in the next as they did in the last.
Management relations
There is a particular demeanor that can be found in the management's investor communications. When writing to investors, it's quite comforting when they refer to IBM as "your company." This is very nice for them to be so rare as to address investors with this proper perspective. It's also nice to see that the executives are being compensated in the proper perspective, as most of their pay is performance based. They even make sure to present this to the investor in a reader-friendly format.
The Unknown
IBM's business model is complicated and evolving, with multiple players in the areas where they compete. This isn't like comparing Dollar General Vs. Family Dollar, in that most of us can't walk in and accurately observe IBM's operations at work. It's extremely difficult for any individual investor to discern which company is building a better cloud, or who makes the best business analytics. We can see how they have performed in the past, but their products and services will ultimately decide what their financial results will look like in the future. Buffett doesn't make mention of it, but I'm willing to bet that having years of long conversations with Bill Gates came in handy for his recent entrance into the technological arena. This is an advantage that we don't have, but we do have the opportunity here to read between the lines as to what he is doing about it.
Certainty Vs Value
Of course, value is important. Pure quantitative value, without considering the future prospects of a business, can be foolish though. Certainty is also important in that any company's future prospects must be understood intimately. A great illusion of value can sometimes be found in companies as they are heading on a straight trajectory towards decimation. So, with these factors in mind, an investor should consider the knowns and unknowns concerning an investment. This brings someone to a degree of certainty, either positively or negatively, as to a company's future probabilities. Then look at the investment value to see if it's worth taking a bet, all while keeping in mind that few things are 100% certain.
IBM's future is a tough puzzle to put together, but the Buffett card changes things as we can see that the world's greatest investor, who also happens to be buddies with Bill Gates, has already taken the business factors into consideration. Perhaps my lack of expertise in this area will keep me from taking a huge bet on them and holding forever, but I will be sure to hold a few shares as long as the results remain steady and the value so evident.
IBM can be played differently depending on one's expertise in this area. However, for the layman investor, their value is strong enough that a small (and more than likely profitable) position can be taken and held as long as PEGR remains below 1, or not too far above it. They sailed right through the last economic downturn as if nothing had happened; it would also be wise to keep a keen eye on whether this history repeats itself.
Disclosure
This is not an investment recommendation but an analytical investigation into a company. Do not be silly enough to take anyone's perspective as infallible, certainly not mine, but make sure to do your own independent research and verification. I own shares in IBM.
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