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Why I Bought IBM?

September 01, 2013 | About:
What a month! I've been trying to keep a tight fist on my capital, seeing an urge to conserve cash in lieu of purchasing equity stakes in high quality companies because I'm feeling a bit cautious about the broader market's modest overvaluation, and in turn the modest overvaluation of a lot of underlying stocks in the market. How have I done in that regard? Poorly!

I've said it before, and I'll say it again: I'm a dividend addict! So, I constantly have this internal tug-of-war where I have the prudent half of my personality clamoring for patience and the eager half of my personality fighting for the further acquisition of shares in high quality companies. A little play on greed and fear, I suppose. A microcosm within my own mind. However, since I don't believe in timing the market (because I wouldn't be good anyhow) I just continue to build my portfolio one company at a time, month after month. So maybe I'm a little more prudent and a little less greedy than I might appear.

The greedy side has been winning handily. I started off the month adding to my burgeoning position inDigital Realty Trust, Inc. (DLR) and quickly followed that up with an addition to shares in Altria Group, Inc. (MO). Then I capped off the buying spree with an initiation of a position into American Realty Capital Properties, Inc. (ARCP). Or, so I had thought. I wasn't as done as I thought I was.

As part of my Recent Buy series, I try to let my readers know of any equities I purchase soon after the transaction is completed. This is just one way I try to document my progress toward early retirement and financial independence.

I purchased 10 shares of International Business Machines Corp. (IBM) on 8/28/13 for $181.47 per share.

I recently wrote about how I'm a fan of IBM at today's valuation and why. The current 52-week low of IBM shares if $181.10, so while I don't know where it goes from here I feel fairly confident in the price of which I paid based on the company's fundamentals and the growth prospects going forward.

IBM is a global information technology company. They've were incorporated in 1911 and have operations in over 170 countries. They operate primarily in three segments: Hardware/Financing, Services and Software.

I'll start by saying I'm not a huge fan of technology companies in general. You can scan across my portfolio and notice that I'm sparsely invested in them. I have one fairly sizable position in Intel Corporation (INTC), but that's only my only straight play on technology. Of course, it's difficult to avoid technology as an investment because companies of all sizes in all industries use technology to build their businesses and grow accordingly.

However, I'm a fan of IBM because of it's ability to adapt. It shifted from being primarily a low-margin hardware provider to focusing on higher-margin software and services operations. It started this transition well over a decade ago and has reaped the rewards in the process. Whereas hardware/financing was 35% of pre-tax income in 2000 it is now just 14% of pre-tax income as of 2012. In the interim, the software segment has mostly filled that space. During this time, pre-tax income margin rose from 10.2% to 22.2%.

Due to such dramatic shifts in the business, IBM is primarily a services and software company. They provide enterprise data solutions to businesses along with the software needed to connect multiple platforms. For instance, they can take raw data and filter it into analytics that businesses need and place a premium on. They're making big moves into Cloud computing and IBM sees a future where there is increasing interconnectivity between the mobile devices people increasingly use, networked services and social enterprises. As such, they've placed themselves as a leader in the industry.

Growth has been strong. Since 2003, earnings per share have grown from $4.34 to $14.37 in 2012. That's a compounded annual growth rate of 13.97%. That growth rate has largely been fueled by one of the biggest share buyback programs in the world. Since 2000, IBM has reduced their share count by over 35%. Revenue growth hasn't been as impressive, but has been quite stable even through a recession and the Great Recession. Since 2003, revenue has a CAGR of 1.78%. The debt/equity ratio is a bit high at 1.5, but the interest coverage ratio is very strong at over 45.

I mentioned this before, but some investors might take some solace in knowing that Warren Buffett is a huge fan of this business. IBM is now the third largest position in the Berkshire Hathaway (BRK.A) investment portfolio, of which Buffett directs. I'll come right out and say that I'm a huge fan of Buffett. And I'm not just a fan of his investment prowess, but his general take on life and the way he presents himself. His keen knowledge on many subject matters is astounding, and the affable manner in which he presents this knowledge is extremely impressive. Buffett has been the most successful investor of the 20th century, and probably the most successful investor of all time. If he's a fan of IBM, I'd say that's a qualitative factor that one may want to consider. He initiated his stake back in 2011, at what is speculated to be an average price of $173. I do quite enjoy knowing I can buy a piece of this blue-chip company for a price not too much higher than what the greatest investor we've ever known bought in at.

Investing in IBM, it's important to be aware of the fact that IBM is a big goal-setter and likes to achieve those goals. Currently, they operate under a 2015 Road Map which dictates that IBM wants to achieve $20 EPS in 2015. As well, they want to return $70 billion to shareholders and invest $20 billion in acquisitions. The $70 billion that plans to get returned to shareholders is broken up into $50 billion in share buybacks and $20 billion in dividends. I'll gladly invest in a company that puts big goals up, delivers on them and puts a priority on rewarding the shareholders.

Of course, we should talk about dividends! IBM doesn't have a particularly exciting entry yield. Sitting at just2.1% on my purchase price, there is room for desire. However, IBM has a particularly phenomenal growth rate of the quarterly dividend. They currently pay $0.95 per share quarterly. That dividend has a growth rate of 18.8% over the last 10 years. They've been growing the dividend for 18 years, which is particularly strong considering they're a technology company. With a payout ratio of just 27%, there is plenty of room in the tank for further significant dividend raises.

I valued shares in IBM in my typical fashion: performing a Dividend Discount Model analysis and compared that to analyst calculations to come up with a reasonable range of intrinsic value. Using a DDM with a 10% discount rate and a 8% growth rate (well below the 10-year average) I get a Fair Value of just over $205 per share. With a P/E ratio of 12.96, I feel comfortable that a comfortable margin of safety exists on IBM shares at the current price.

This purchase adds $38.00 to my annual dividend tally based on the current quarterly payout of $0.95 per share.

I'm currently invested in 39 companies, as this was a new investment.

Some current analyst opinions my recent purchase:

*Morningstar rates IBM as a 4/5 star valuation with a Fair Value estimate of $208.00

*S&P Capital IQ rates IBM as a 4/5 star Buy with a Fair Value calculation of $230.40.

I'll update my Freedom Fund in early September to reflect my recent addition.

Full Disclosure: Long DLR, MO, ARCP, IBM, INTC

What do you think of my recent buy? Are you a fan of IBM at today's prices?

Thanks for reading.

About the author:

Dividend Mantra
Trying to retire by 40 by investing in dividend growth stocks and living frugally, valuing time over money.

Visit Dividend Mantra's Website


Rating: 1.9/5 (17 votes)

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