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The Science of Hitting
The Science of Hitting
Articles (469) 

Why I Sold IBM

After owning the stock for a few years, I've decided to sell my position

December 28, 2017 | About:

Over the past few quarters, I’ve become increasingly uncomfortable with my investment in IBM (IBM). After a lot of thought, I decided that it made sense to sell my entire position (which I did on Wednesday). I wanted to share some of the considerations that led me to this conclusion.

Weak results

Over the past few years, the results from IBM’s “Strategic Imperatives” have been pretty good. At the same time, the results for IBM’s legacy businesses have gone from bad (mid-single digit revenue declines) to worse (double-digit revenue declines in recent quarters). This has led to a consistent (albeit slow) decline in IBM’s revenues despite help from a number of acquisitions.

Profit margins have been under pressure as well, which has constrained profitability: guidance calls for fiscal 2017 non-GAAP EPS of at least $13.80 per share – about 15% less than the company earned four years ago. This looks even worse relative to the long-term guidance (high-single digit EPS growth) that management has reiterated each of the past three years.

Many investors (myself included) will point to the fact that at some point, the decline in the legacy businesses will be more than offset by growth in “Strategic Imperatives” – assuming the current trends hold. Personally, I’m not as comfortable with that assumption as I was a few years ago. As opposed to a company like Microsoft (MSFT), I’m not convinced IBM has turned the corner. I continue to see data points that suggest the opposite may be true (the results of a recent Goldman Sachs IT Survey, published in mid-December, is a notable example).

Over the past five years, IBM’s earnings power has not improved; I don’t have a high degree of confidence that this will change over the next five years.

Warren Buffett (Trades, Portfolio)

I discussed the relevance of Warren Buffett (Trades, Portfolio)’s involvement at IBM during my most recent year-end portfolio review:

I don’t take comfort in much of what I read about the continued success of emerging competitors like Amazon (AMZN); this is exacerbated by the fact that I do not have the industry expertise required to understand the potential developments in this business over the next five-plus years.

In the past, I’ve accepted that reality by leaning on two crutches: one, the valuation, and two, Warren Buffett’s continued ownership of the stock. The first point is less compelling if the stock continues to climb; the second point isn’t the way I prefer to operate either, regardless of how cheap the stock appears. That’s a long-winded way of saying that I’m likely to sell shares of IBM in 2017; I think my time and efforts could be better spent elsewhere.

As most readers likely know, Warren Buffett (Trades, Portfolio) has been a major seller of IBM shares as of late. At the end of the most recent quarter, Berkshire Hathaway owned roughly 37 million shares of IBM. By comparison, Berkshire Hathaway held more than 81 million shares of IBM at the end of 2016. The numbers speak for themselves.

I can live with the fact that Warren Buffett (Trades, Portfolio) – the investor – is selling the stock.

What really concerns me about this move is the knowledge that Warren Buffett (Trades, Portfolio) brings to the table as the CEO of Berkshire Hathaway (with insight into the decision-making of dozens of operating businesses). Consider what Buffett said when he initiated his position in IBM:

“We went around to all of our companies to see how their IT departments functioned and why they made the decisions they made. And I just came away with a different view of the position that IBM holds within IT departments and why they hold it and the stickiness and a whole bunch of things… I don't want to push the analogy too far because it could be pushed too far, but we work with a given auditor, we work with a given law firm. That doesn't mean we're happy every minute of every day about everything they do but it is a big deal for a big company to change auditors, change law firms. We've got dozens and dozens of IT departments at Berkshire. I don't know how they run. I mean, but we went around and asked them and you find out that they very much get working hand in glove with suppliers. That doesn't mean things won't change but it does mean that there's a lot of continuity to it. And then I think as you go around the world, IBM, in the most recent quarter, reported double-digit gains in 40 countries. Now, I would imagine if you're in some country around the world and you're developing your IT department, you're probably going to feel more comfortable with IBM than with many companies.”

If IBM’s position isn’t quite as sticky as once thought, that’s a major concern for investors. Over the past few years, I've seen numerous data points that indicate this is exactly what’s happening (as an example, take a look at the growing list of enterprise customers that are moving to AWS).

Warren had another unique opportunity to assess IBM’s value proposition to clients: as he noted during a CNBC interview in early 2016, GECIO was involved in a “fairly elaborate experiment” with Watson that they had been working on “for quite a while.” When Warren was asked about Watson again in May, he added that when “other very smart people have been given some time to work on other products… you have to worry about somebody jumping the utility of something like [Watson].”

Over time, Warren's words and his actions suggest that he has become less certain about IBM’s future. Considering where he’s coming from, that conclusion carries a lot of weight in my book.

Conclusion

Despite owning IBM for a few years, I still do not have a strong sense for what this business will look like five to ten years down the road. I used Warren Buffett (Trades, Portfolio)'s vote of confidence as a crutch on this investment – and if he’s selling, I should do the same. Unlike my other holdings, I have not dealt with IBM’s price swings with equanimity. In my experience, that’s a good sign to head for the exits and focus my efforts elsewhere (no matter how delayed that conclusion may be).

If I didn’t own IBM, I wouldn’t buy it today. Sticking with the stock solely because I thought it made sense previously (and to avoid admitting “defeat”) would be another error.

As always, I look forward to your feedback.

About the author:

The Science of Hitting
I'm a value investor with a long-term focus. As it relates to portfolio construction, my goal is to make a small number of meaningful decisions a year. In the words of Charlie Munger, my preferred approach to investing is "patience followed by pretty aggressive conduct". I run a concentrated portfolio, with a handful of equities accounting for the majority of its value. In the eyes of a businessman, I believe this is sufficient diversification.

Rating: 4.2/5 (9 votes)

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Comments

mocheng
Mocheng - 3 months ago    Report SPAM

i was thinking about selling my position in IBM today as well, I am in IT field and I am seeing IBM business in decline, their servers are way too expensives, as well as their software. They are facing much cheaper competition from AWS and Linux.

jorgecaj1974
Jorgecaj1974 - 3 months ago    Report SPAM

I will gladly buy your shares. I acutally bought IBM today. YOU buy when everything is going wrong with the potential of higher grwoth. That is clearly happening. Looking at it from a yearly perspective the yearly close is right on the money. From A time perspective the low this year is on the money from a time calculation. From a valuaton stand point IBM can double. IBM looks similar to FSLR , RL, etc. As far as Buffet is concerned. He sold WMT at the low. and jumped on aapl late. He got lucky he bought in one of the greatest bull markets of our time. but he is not the best at picking stocks. He is the best at time. Time to hold for a long time. IBM is going parabolic next year.

The Science of Hitting
The Science of Hitting - 3 months ago    Report SPAM

Mocheng - Sounds like you have more knowledge in this area than I do; thanks for sharing!

The Science of Hitting
The Science of Hitting - 3 months ago    Report SPAM

Jorgecaj1974 - I have no idea what IBM (or any other stock) will do over the next year, but will definitely admit that IBM appears cheap if they can turn things around. Personally, I'm not comfortable making that assumption. Best of luck with your investment!

feo1966
Feo1966 - 3 months ago    Report SPAM

Jorgecaj1974....."IBM is going parabolic next year"

Seriously? Do you have a crystal ball. Nobody can predict if a stock will take off.

jorgecaj1974
Jorgecaj1974 - 3 months ago    Report SPAM

Feo1966...Why is it you think no one can predict of a stock will take off? Have you ever tried and what strategy did you use to predict when a stock is going to take off?

snowballbuilder
Snowballbuilder - 3 months ago    Report SPAM

Hi science , thanks for the update

I think you Have made a good decision

I m waiting your year end report

Best for the 2018

Ps in My opinion i think is important to remember

- that the presence of buyback alone is worth little or nothing.. Is critical to study and understand If that buyback is value accrescitive at per share value and If is the best way to invest the company free cash flow.

- the fact that BRK has bought / sold the stock alone is not worth much ... If Is a tecnology company...

Just some thoughts

Best snow

Carol Nadon
Carol Nadon premium member - 3 months ago

IBM is ahead in bloclchain technology on some areas like banking and food industries:

http://www-03.ibm.com/press/us/en/pressrelease/53013.wss

https://www-03.ibm.com/press/us/en/pressrelease/53290.wss

The Science of Hitting
The Science of Hitting - 3 months ago    Report SPAM

Snow - The year-end article should be available later today. I look forward to your thoughts!

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