The headline of a Reuters article stated the following: “Buffett says owning IBM shares could prove a mistake.” A Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) shareholder may worry about the company’s ongoing paper loss of ~$2 billion, but a more suitable train of thought, for value investors, would be to figure out whether or not International Business Machines (IBM, Financial) is undervalued and worth investing in.
I will use four different valuation methods here –Â not learned from any MBA program, but I use them in most of my intrinsic calculations.
Before starting the calculations, some financial data about IBM’s historical performance:
Operating, gross and profit margins
In 10-year visualization, margins are trending up.
Percentage dividend and share buyback over profits and free cash flow
IBM appears to have been providing most of its earnings and/or cash flow to its shareholders over the past decade.
Profits and growth
For the past 10 years, profit growth definitely has slowed and was worst in 2014.
Free cash flow and growth
Free cash flow peaked in 2009 and has not been at those levels since.
Debt to equity
Not a good sign here –Â as I seek
Net debt
Minus cash, the company’s debt is still on an uptrend.
Profits vs. total debt
Data revealed that the company has been incurring debt regardless of its profits. Red box indicates when Buffett initiated his IBM stake. He bought roughly 4.5 million shares at $163 per share.
Free cash flow vs. total debt
Revenue and growth
Revenue had been on a decline since 2012.
These numbers show that IBM has been demonstrating disappointing numbers for the past five years or so.
Valuations
Determining growth can be interesting. Obviously, IBM has negative growth in its profits or cash flow from the above figures. I will use the forecasted growth rate from Yahoo! (YHOO, Financial) Finance by analysts but average next year’s and next five years' forecasted numbers to provide my estimated growth version for the next decade, which is 6.125%.
Revised Graham formula
Simple multiple
Capital Asset Pricing Model (CAPM)
Other data not included in the graph above were as follows: Ten-year Treasury rate of 1.85% was used for risk-free rate, beta average of 0.66 from different financial resources, equity risk premium from Professor Aswath Damodoran’s NYU Stern data, and corporate debt interest rate of 2.36% and tax rate of 16%.
On average, my intrinsic value calculation for IBM is $210 per share. Removing Graham’s revised formula, I have $145 per share.
Takeaway: Depending on which valuation one would look at and compare to today’s IBM price, it is undervalued.
Disclosure: I am long IBM.
Happy Investing!
Mark Yu
Also check out:
