Why Warren Buffett Keeps Buying IBM.

After reading about the company for 50 years
without making a move and shunning the entire
tech sector for the majority of his career, Warren
Buffett suddenly picked up over $10 billion in
shares of IBM (IBM) recently for his company,
Berkshire Hathaway (BRK.A)(BRK.B). Buffett said in
Nov. 2011 on NBC when he announced owning a
stake in the company that “he would not be
announcing it if he were not pretty much done”
buying shares. But over the next three quarters he
has found the stock attractive enough to continue
buying, making it the second most-bought stock in
his portfolio, and causing investors to ask why.
(Read about why he is buying his most-purchased
stock, Wells Fargo (WFC) here.)
Purchasing History
Buffett began to buy IBM shares in the first quarter
of 2011, with 4,517,774 shares for a price of $159
on average. Purchasing became more aggressive in
the second and third quarter when he cumulatively
bought more than 82.2 million shares for $167 and
$173 on average. From the fourth quarter of 2011,
to the third quarter of 2012, he made smaller
purchases at average prices ranging from $185 to
$197.
By the end of the third quarter, he owned a total of
67,517,896 shares, which equals 5.98% of IBM’s
shares outstanding. It also made the company an
18.6% weighting in Buffett’s portfolio.
Management – Business Execution
Buffett praised IBM CEOs Lou Gerstner and Sam
Palmisano in his 2011 annual letter for rescuing IBM
from the brink of bankruptcy 20 years ago and
making it into a successful business today. In
addition to their “extraordinary” operational
accomplishments, “their financial management
was equally brilliant,” Buffett said, “particularly in
recent years as the company’s financial flexibility
improved. Indeed, I can think of no major company
that has had better financial management, a skill
that has materially increased the gains enjoyed by
IBM shareholders.”
IBM consistently uses “Road Maps” to create
targets for the future and measure progress in the
present. Buffett was impressed that the company
had met its benchmarks for a plan introduced in
2007 called the 2010 Road Map, and in 2011 proved
it is on its way toward the goals set forth in the
2015 Road Map that replaced it. In 2010, the
company surpassed its 2007 goal of $10 to $11 in
earnings per share by reaching EPS of $11.52 in
2010.
The company’s 2015 map focuses on the major
drivers of its earnings per share performance:
operating leverage, share repurchases and growth
strategies. Specifically, according to the company’s
10-K, highlights of the metrics it is aiming for
include:
· $50 billion in share repurchases
· $20 billion in dividends
· $20 in EPS (non-GAAP)
· $100 billion in free cash flow
· $20 billion spending on acquisitions
· Software becoming about half of segment profit
· Growth priorities:
1. Growth markets unit accounting for 30 percent of
segment revenue by 2015 (it was 21 percent in
2010)
2. Analytics growth to $16 billion in revenue
3. $7 billion in revenue from cloud computing
4. Smarter Planet solutions to grow to $10 billion in
revenue
In 2011, the company had achieved the following
progress toward its 2015 goals:
· $3.473 billion paid in dividends (9.32% increase
year over year)
· $15.05 billion in share repurchases
· $13.44 in diluted operating (non-GAAP) earnings
per share (a record)
· $16.6 billion in free cash flow (a record)
· $1.8 billion for five acquisitions in software
· Software and services was 44% of segment profit
· Growth Priorities:
1. Growth markets accounted for 22% of geographic
revenue (an 11 increase from 2000)
2. 16% revenue growth year over year
3. 200% revenue growth year over year
4. 50% revenue growth year over year
IBM said 2011’s positive financial performance
resulted from the transformation it began year ago
to shift the business “to higher value areas of the
market, improving productivity and investing in
opportunities to drive future growth. These changes
have contributed to nine consecutive years of
double-digit earnings per share growth.”
Some of the changes involved in the transformation
include exiting its PC and hard disk drive
businesses in time for the dramatic slow-down that
would take place in those industries. It also
introduced new businesses like products, services,
skills and technologies into the mix.
The focus on growth and investment in innovation
allowed the company to enter new markets and
delve into new waves in the technology sphere
such as business analytics and cloud computing.
Moat
This transition has transformed the company into a
service company instead of a hardware/software
company. Buffett in his CNBC interview noted that
companies are reluctant to change their IT suppliers
and as companies around the world look for
companies to develop their IT departments, they
are likely to turn to a trusted and iconic name like
IBM.
Business Metrics
Buffett said on CNBC that American businesses
were a great place to put money currently,
specifically businesses that “are earning very good
money, that have high returns on equity, have high
returns on incremental capital, are buying in their
stock at a rapid rate so that your ownership in the
business increases significantly.”
In IBM’s case, it has:
· Return on equity – In 2009, 2010 and 2011, IBM
generated return on equity of 59%, 64% and 78.4%,
far higher than in the earlier part of the decade.
· Stock repurchases – IBM has a strong history of
repurchasing shares. Buffett said he would be
happy to see IBM reduce its share count to 64
million shares. Since 2003, the company has
decreased its share count annually, from 1.72
billion in 2003 to 1.179 billion in 2011.
Though future earnings primarily will determine
Buffett’s success in IBM, Buffett said in his 2011
letter, he hopes the stock prices languishes
because the amount of he is able to purchase with
the amount of money they dedicate toward
repurchases was “an important secondary factor.”
The more shares it is able the buy, the greater the
percentage of the company he will own.
Buffett bought IBM at near historical-high prices. In
the past year its stock price has increased almost
6%. It has a P/E of 13.5, P/B of 10.2 and P/S of 2.

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6 thoughts on “Why Warren Buffett Keeps Buying IBM.

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