Warren Buffett sat out the Dot Com Bubble of the late 1990s, just as he had refused to partake in a similar mania in the 1960s, because fast-changing technology companies are inherently difficult to predict, prices were sky-high and, besides, he's a self-described "luddite." The value of a business lies mostly in the earnings that it will generate over time, and a wildly unpredictable future makes it too difficult to reliably value a business. Long time Buffett followers were surprised, then, when the technophobic investor announced a $10.9 billion stake in IBM. For as long as anybody can remember, paradoxically, the company has been leading the world into the mysterious future. What was the Oracle of Omaha thinking?
Though the company is indeed one of the world's most innovative, its business model, Buffett explained, is slow-moving and "sticky." That is, the company's "switching costs" are high. When the IT manager of an institution contracts IBM, the business's hardware, software, systems and staff become intimately entwined with Big Blue. The costs of untangling - in time, money and risk - are high. It's neither quick nor easy to move to a competitor's system: staff may need retraining, hardware may need to be replaced, and data could be corrupted, lost or stolen. It's a hassle. Besides, competitors have the same will and ability to hold on tightly to clients. For IBM, however, it creates a solid, predictable revenue stream, and an installed base to add new products and services onto.
IBM not only retains existing customers, the firm pursues new business very aggressively. Deep Blue checkmated grandmaster Gary Kasparov, Watson outwitted even Jeopardy's foremost contestants - and each dramatic "machine-over-man" encounter gave IBM the opportunity to demonstrate both its technical prowess and its canny salesmanship. When there's new business to be awarded, IBM will get its share.
The historical financials show not a capricious, shape-shifting hi-tech business, but a steadily growing earnings machine.
From 2003-2011 earnings grew at a compound annual rate of 12% per year, EPS was even higher, at nearly 17%, due to share repurchases, and return on equity improved from high to radically high (the average North American business returns 10%-12% on equity).
Year
|
2011
|
2010
|
2009
|
2008
|
2007
|
2006
|
2005
|
2004
|
2003
|
Earnings
|
16.3
|
14.8
|
13.4
|
12.3
|
10.4
|
9.5
|
8.0
|
7.5
|
6.6
|
EPS
|
13.06
|
11.52
|
10.01
|
8.89
|
7.15
|
6.05
|
4.91
|
4.39
|
3.76
|
ROE
|
79%
|
67%
|
80%
|
49%
|
43%
|
29%
|
25%
|
24%
|
25%
|
From 2003-2011 earnings grew at a compound annual rate of 12% per year, EPS was even higher, at nearly 17%, due to share repurchases, and return on equity improved from high to radically high (the average North American business returns 10%-12% on equity).
There's reason to expect the foreseeable future to be nearly as attractive as the recent past. Buffett approvingly cited the company's ambitious 5-year "road maps," which it consistently delivers on. Between 2010 and 2015, IBM has pledged to return $70 billion to shareholders via dividends and buybacks make $20 billion of acquisitions and reach at least $20 per share in earnings. Given that less than a quarter of revenues currently come from the fast-growth BRIC markets, and the company's move away from low-margin hardware sales to high-margin software and services offerings, it's all but guaranteed that the company keeps its promises.
Assuming a 17.5x multiple times 2015 earnings of $20 per share, plus another $15-17 in remaining dividend payments, an investor that buys the stock at its current sub-$200 price stands to gain around 20% per year over in IBM over the next three and a half years. Not only is there virtually no business risk, there is very little financial risk given the company's steady results, its low-capital business model, and its sound financial position. Since the company is a large-scale, long-term buyer of its own shares, there’s at least a soft floor under its share price, though the lower it goes, the happier patient investors will be, since their per share economic interest in the company will increase. On the whole, the company has significant upside and very little downside.
Disclosure: The author had no position in IBM at the time this article was published.
Disclaimer: The host of this blog shall not be held responsible or liable for, and indeed expressly disclaims any responsibility or liability for any losses, financial or otherwise, or damages of any nature whatsoever, that may result from or relate to the use of this blog. This disclaimer applies to all material that is posted or published anywhere on this blog.
No comments:
Post a Comment