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IBM Doing Exactly What Warren Buffett Wanted
Dec. 22, 2014 5:36 PM ET | by Tim McAleenan Jr. | about: ibm | includes: brk.a, brk.b
Summary
- Many critics of IBM have been focusing on the company's difficulty transitioning to the cloud, and poor stock price performance this year.
- The company, however, has spent $19.2 billion repurchasing its stock in the past year, and has grown earnings by a double-digit amount over the course of 2014.
- Warren Buffett specifically desired strong buybacks at low prices in his letter to shareholders, and his desire has been coming to fruition with IBM over the course of 2014.
Many of you are already familiar with Warren Buffett's declaration in his letter to shareholders of Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) that he hopes the price of IBM Corp. (NYSE:IBM) stock languishes in the market while he holds it. To wit, Buffett specifically said:
The logic is simple: If you are going to be a net buyer of stocks in the future, either directly with your own money or indirectly (through your ownership of a company that is repurchasing shares), you are hurt when stocks rise.
You benefit when stocks swoon. Emotions, however, too often complicate the matter: Most people, including those who will be net buyers in the future, take comfort in seeing stock prices advance. These shareholders resemble a commuter who rejoices after the price of gas increases, simply because his tank contains a day's supply.
Charlie and I don't expect to win many of you over to our way of thinking - we've observed enough human behavior to know the futility of that - but we do want you to be aware of our personal calculus.
Most IBM shareholders are aware of how the company's stock price has gone down from $199 in April to $160 today, and consider that some kind of indictment on the company's long-term prospects. What I find interesting, though, is that IBM's own history proves the point that Buffett made: the truly long-term shareholders of IBM really do benefit from a lower share price.
The last time that IBM's share price languished like this occurred during the financial crisis years of 2008 and 2009. In 2007, it traded at a high of $120 per share. In the coming two years, the recession-inspired prices in the stock market enabled the company to retire about 300 million shares by the time 2010 came around. At the time, it probably didn't seem fun for IBM shareholders to see the price of the stock fall from $120 to under $70.
Yet, if you step back and study what actually happened when IBM retired those 300 million shares at languishing prices, the company managed to increase its earnings per share from $7.18 in 2007 to $11.52 in 2010. The decline in the price of IBM stock was the friend of long-term shareholders, because the buyback helped increase profits by 60% cumulatively.
In the past year, a new act in the same play is unfolding before our very eyes, as IBM is again using a moment of low stock prices to retire a significant amount of stock that is having an outsized impact on earnings per share growth. The conversation about Intel during the past year has generally focused on the price of the stock that has fallen from $190 to $160, the management team's abandonment of the $20 earnings per share target in 2015, and general concern about IBM's transition to the cloud.
What has gone unobserved is this: IBM has repurchased $19.2 billion worth of its own stock in the past year, and paid out $4.2 billion in dividends. The company makes $17.1 billion in net profits, so it has borrowed $5 billion in the past year to retire an unusually high amount of stock, based on the premise that retiring stock purchased at 9x profits will create extra value for shareholders in the long run.
IBM has reduced its share count from over 1 billion to 985 million, and this has enabled the company to grow its earnings per share from $14.94 in 2013 to $16.95 in 2014. That is what has gone unnoticed during the constant ridiculing of IBM this year: the company has grown its earnings per share by 13.45%, and this high growth rate would not have been possible if the valuation of IBM had not become so attractive (as an aside, you should note that many stock screeners state an earnings per share for IBM below the $16.95 figure because they calculate their quotes based on weighted average shares outstanding over the previous ninety days, rather than the most current share count).
For historical perspective, the last time IBM traded below 10x earnings was in early 2009. If you had purchased shares of the stock at that point in time, you would have compounded your wealth at a rate of 12.35% in the following five years. The shares are at approximately what Warren Buffett wanted: they are languishing at a price that understates IBM's long-term earnings power, and the management team is taking advantage of that fact to buy a significant amount of stock. The earnings per share of IBM jump by the greatest amount in years like 2009 and 2014, when the valuation is incredibly attractive around the 10x earnings range. While IBM continues to remain unfashionable, earnings per share continue to grow at a double-digit rate. Don't question whether the Oracle of Omaha has lost his golden touch just yet.
Disclosure: The author is long IBM. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
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