One of the most significant mistakes Warren Buffett (Trades, Portfolio) has made in the past decade was acquiring a substantial stake in IBM back in 2011. After repeatedly saying that he would not invest in technology for much of his life, in 2011, the Oracle of Omaha built a $12 billion position in IBM (IBM, Financial).
Unfortunately, this trade did not work out. However, it was a learning experience and perhaps laid the foundations for what has become one of the most profitable investments in Berkshire Hathaway's (BRK.A, Financial) (BRK.B, Financial) history: its current position in Apple (AAPL, Financial).
Buffett and IBM
When Buffett first acquired the stake in IBM, he believed that the company would adapt to the changing environment in the tech space, as it had done many times before in its life so far.
Speaking on CNBC soon after the holding was revealed, Buffett said that he'd been "hit between the eyes" by the advantages the company enjoys in finding and keeping clients. "It's a company that helps IT departments do their job better," he said.
"It is a big deal for a big company to change auditors, change law firms," or for IT departments, to move away from using IBM, he said. "There is a lot of continuity to it."
Buffett also said that the company's plans to return a significant amount of cash to investors with buybacks and dividends were crucial contributors to his investment case. He explained in his 2011 annual letter to investors:
"In the end, the success of our IBM investment will be determined primarily by its future earnings. But an important secondary factor will be how many shares the company purchases with the substantial sums it is likely to devote to this activity."
Buffett held on to IBM until 2017, but investors started to express misgivings about the position in 2015. At the 2015 annual meeting of Berkshire's shareholders, one investor asked Buffett's right-hand man, Charlie Munger (Trades, Portfolio), if he'd tried to talk Buffett out of buying IBM as the company had all the hallmarks of the cigar butt style investments that had helped build the foundations of his fortune. Munger stated that he hadn't tried to talk Buffett out of the position. He went on to add:
"I think IBM is a very interesting company. It totally dominated Hollerith machines, you know, the punch card computing. And then when they invented electronic computing, it dominated that for a while. It's very rare that when a technological change comes along that people adapt as successfully as IBM did that time...IBM is still an enormous enterprise. I think it's still a very admirable enterprise, and I think we bought it at a reasonable price."
Unfortunately, IBM has struggled to adapt to the latest rounds of technological change over the past decade. Buffett finally admitted that fact in 2017, saying:
"I don't value IBM the same way that I did six years ago when I started buying. I've revalued it somewhat downward. IBM is a big, strong company, but they've got big strong competitors, too."
Berkshire dumped its holding in IBM that year. As I noted in a previous article, this investment wasn't a complete disaster. I put the estimated holding period return at 5% overall, including dividends. Berkshire might have been better off investing the money in fixed income over the six years from 2011 to 2017. Still, at least the return was positive.
We can learn a valuable lesson from Buffett's IBM trade. Yes, the investment turned out to be a mistake. However, I think it is reasonable to say that during the holding period, Buffett may have learned a lot about the tech industry, IBM's strengths and weaknesses, and, more importantly, the strengths and weaknesses of its peers. This information may have helped reinforce his conviction to buy Apple.
Buffett moved on from his error and bought a business that he believed had much brighter prospects. Admitting the mistake and moving on has earned Berkshire tens of billions of dollars in profits.
Disclosure: The author owns no share mentioned.
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