1. How to use GuruFocus - Tutorials
  2. What Is in the GuruFocus Premium Membership?
  3. A DIY Guide on How to Invest Using Guru Strategies
Josh Zachariah
Josh Zachariah
Articles (89) 

Buffett's Unorthodox Investment in IBM?

The recent news of Warren Buffett’s investment in IBM, let alone the sheer size of the position at $10 billion, came as a great surprise to many. The tech business hardly fits the mold of the traditional company Buffett invests in. A feature of IBM that did fit the traditional mold was the high returns to equity the company yields. I nearly fell out of my chair after seeing IBM’s previous couple years of returns to equity. The five-year return to equity average was 49.88%, with the last year clocking in at 64%. Using the Google Stock Screener and limiting firms to those above $1 billion and five-year returns to equity above 49%, only 47 other companies meet the cut. Even in the late '90s IBM was showing returns to equity in the mid 30%, so the company has certainly been rewarding investors of late (for those unfamiliar with the metric and Buffett’s preference for it, this article offers a great analysis). The return to equity figure is explained by its underlying products: profit margin, leverage and sales turnover and IBM’s mouth watering figure can further be elucidated by its recent history.

IBM has spent the last 10 years in a restructuring phase. As is reiterated in the recent annual report, the company is exiting commoditized businesses and further differentiating itself from competitors. Historically IBM had been a mainframe and hardware company, but as is evident by its financials it has evolved into somewhat of a software company. Software accounted for 43% of 2010 pre-tax income yet it produced only 22% of the company’s revenue.

From the 2010 10-K, figures in millions


Software companies like Microsoft have exceptionally high profit margins so the high margins in the software segment should come as no surprise. Microsoft’s 33% profit margin easily trounced IBM’s 14% in 2010, but IBM’s 64% return on equity bested Microsoft’s 40%. In the late '90s and early 2000s IBM had profit margins in the single digits, so perhaps it was the movement into software that has brought the net margin up.

Still, the slightly higher profit margins can’t explain the high returns to equity; instead the reason appears to be a gorging of debt. Over the past 10 years IBM has grown its debt to equity ratio some 40%. Microsoft just recently took on significant amounts of debt, but as a proportion to equity it has a much smaller figure than that of IBM. Taking on large sums of debt has the effect amplifying return to equity as net income is spread out over fewer shareholders. If Microsoft were to take on the kind of debt IBM has, its returns to equity would look even better than IBM’s.

The last factor in the return to equity metric, the sales turnover was fairly average. In 2010 IBM produced $99.8 billion in revenue on $113.4 billion of assets leaving the company relatively unchanged in asset efficiency over a 10-year span.

Like Microsof, IBM is very cash-flow rich and earns its interest charges many times over. But IBM’s large amount of leverage makes it unusual in the tech sector. Microsoft (NASDAQ:MSFT), Apple (NASDAQ:AAPL) and Oracle (NYSE:ORCL) all have more equity than debt in their balance sheets. As much a cash cow as Coca-Cola (NYSE:KO) is, it too holds a much lower debt to equity ratio than IBM. This makes Buffett’s investment somewhat vexing as he has generally shied away from companies with excessive amounts of debt. With the investment in IBM, Buffett certainly took a step in a new direction, in more ways than one.

Josh Zachariah

About the author:

Josh Zachariah
I credit my father and Warren Buffett for molding me into the investor I am today.

Rating: 3.9/5 (14 votes)


Please leave your comment:

Performances of the stocks mentioned by Josh Zachariah

User Generated Screeners

ligeron.4gJoel Greenblatt
liuzishuNon-Div Beneish EV/EBITDA
liuzishuNon-Div Beneish ROA/E
alberto.lopezblancoMomentum / Deep Value_V2
alberto.lopezblancoMomentum / Deep Value_volume
alberto.lopezblancoAdquirer's Multiple
HOLKLSUTest First Group Trump Trade
pbarker46Begin here, dividend growth
Get WordPress Plugins for easy affiliate links on Stock Tickers and Guru Names | Earn affiliate commissions by embedding GuruFocus Charts
GuruFocus Affiliate Program: Earn up to $400 per referral. ( Learn More)

GF Chat