The last time that Warren Buffett (Trades, Portfolio) admitted he made a big mistake was buying ConocoPhillips. He misjudged the oil price trend. As long as he realized it was a mistake, he did not hesitate a trading day to sell a big portion of it. Buffett is not God (he said that position had been taken), but he is a genius. A genius admitted his mistake and corrected it fast. ConocoPhillips is not the first, and probably not the last mistake that the all-time-Guru will make.
Could IBM be his next big mistake?
Judging by IBM’s return relative to the market in the past two years, the investment seems a big mistake. But you cannot make a good judgment in just two years. Maybe Buffett even welcomes the decline of the stock price, because as he put it ”if during the next 5 years, IBM stock price declines, it will be even cheaper to buy back those stocks, and If IBM continues to buy back their stock, I will be the only shareholder left”.
| Table 1: Buffett's IBM Return vs. S&P 500 | ||||||||||
| Year | IBM Shares Owned | Percent of Ownership | Cost (in millions) | Cost per share | Market Value (in millions) | IBM earnings Per Share | Market price | Unrealized Gain/Loss | Buffet Total Return in IBM | S&P index Total Return |
| 2011 | 63,905,931 | 5.50% | $ 10,856 | $ 170 | $ 11,751 | $ 13 | $ 184 | $ 895 | 8% | 0% |
| 2012 | 68,115,484 | 6% | $ 11,680 | $ 171 | $ 13,048 | $ 14 | $ 192 | $ 1,368 | 12% | 12% |
| 2013 | 68,121,984 | 6.30% | $ 11,681 | $ 171 | $ 12,778 | $ 15 | $ 188 | $ 1,097 | 9% | 37% |
| 2014 | 76,971,817 | 7.80% | $ 13,157 | $ 171 | $ 12,349 | $ 12 | $ 160 | $ (808) | -6% | 51% |
| Notes: gain/Loss does not include dividends | ||||||||||
Instead of using stock performance for the last two years as the yardstick, or waiting to see its stock price 10 years later, there is another way to judge Buffett’s IBM call. Let’s look at the three major reasons that Buffet explained why he bought IBM and decide whether those reasons still hold, given what we know today:
1. Clear Roadmap and Delivery of Promise
If a company can give a clear road map every five years and always reach the destination five years later, it should have earned its credibility of both vision and execution. No wonder this is the primary reason why Buffett bought IBM after reading its annual statement for 50 years. In his interview with CNBC in late November 2011, Buffett first revealed his secret purchase of IBM. Why IBM? He said:
“I don't think there's any company … that's done a better job of laying out where they're going to go and then having gone there. They have laid out a road map and I should have paid more attention to it five years ago where they were going to go in five years ending in 2010. Now they've laid out another road map for 2015.”
IBM did layout their 2015 road map in 2010. You can find details of this road map envisioned by former CEO Sam Palmisano in 2010 here: Roadmap 2015 pledge. Will they “go there” as before? We already know the answer. On October 20, 2014, IBM officially abandoned its road map for 2015, including the goal of $20 EPS by 2015. For details, see IBM Gives Up On Its 2015 Promise.
The future of enterprise computing is in the cloud, and IBM’s future there is clouded.
2. Stock buyback
In his 2011 letter to shareholders, Buffett said “We should wish for IBM’s stock price to languish throughout the five years”, because IBM can repurchase its shares at a lower price and increases Buffett’s percentage holding at IBM. Well, be careful of what you wish. Now IBM stock is down to around $160 from $200, would IBM take advantage of the lower price to buyback more? No, IBM decided to buy back less. In fact, IBM will cut its stock buyback amount by half in 2015. Please see IBM Cuts Buybacks to 11-Year Low as It Reduces Earnings .
Even IBM is less confident of their stock now.
Buffett, however, did took advantage of the lower market price to increase his ownership at IBM. His 2014 annual shareholder letter revealed that he added far more shares in 2014 than previous two years combined. His latest purchase, according to data compiled by Gurufocus, had an average price of $160, lower than his overall average cost of $171.
3. Sticky product
Yes, IBM products and services are still sticky, but so were Blackberries. Cloud is the new world and companies do not want to be glued to the old regime. The existing customers might decide switching is still costly and time consuming, but IBM would find it increasingly difficult to win new customers. Without new customers, the growth is gone.
Bottom line, there are three major cracks in Buffett’s themes of buying IBM. It gave up its own road map, it slowed stock repurchase, and the stickiness of its products is getting loose. However, Buffett’s purchase of IBM is also sticky, glued by his reputation. He would give IBM one more chance to dance.
Of course, there is always a chance that IBM can reinvent itself as a major player in the cloud. If the elephant can dance again to a new tune, stock could double in 5 years. However, that is not the reason Buffett bought IBM.
Buffett’s famous annual letter to shareholders was just published. It did not discuss IBM seriously. But it certainly will one day.
Disclaimer: the analyses and opinions here are subject to errors and human biases. Those opinions cannot substitute your own rigorous research. You are responsible for your own investment decisions. I own some IBM shares.
