I recently was speaking with a professional fund manager about investments, and he criticized my IBM idea simply because "everyone knows about IBM" and suggested that ideas should be found among the less followed smaller market cap stocks.
I respectfully disagree.
Micro caps are great, but when Mr. Market throws a wonderful business like Big Blue at you for cheap, it's irrational to refuse action simply because IBM is widely followed.
Anyway, here's why I put almost 1/3 of my capital in IBM:
Over the past few decades, IBM has evolved from a hardware
company into the 800 pound gorilla of the business services and technology
services industries.
The company is truly global in scale, operating in over 170 counties. In addition to these economies of scale, IBM enjoys high switching costs due to very “sticky” relationships with clients. (Many of IBM’s contracts are set for 10 or more years) Consequently, IBM is so ingrained in global business and technology services that it would simply cost too much for many companies to switch away from IBM. Additionally, IBM has an extremely valuable brand. The brand is valued at 4th in the world by Interbrand. http://www.interbrand.com/en/best-global-brands/2013/Best-Global-Brands-2013.aspx These competitive advantages existing in combination (scale, high switching costs, and a formidable brand) creates an exponentially stronger business than one that only had one or two of these advantages.
Next, we’ll examine some quantitative evidence of these competitive advantages at work. The first thing that jumps out is IBM’s consistently outstanding returns on shareholder equity. The 10 yr avg is 50% and, incredibly, steadily increasing. It was 65% for 2010, 75% for 2011, and an insane 85% for 2012. That level of profitability puts IBM in the top 2 or 3% of all publically traded American businesses.
IBM has also grown per-share earnings remarkably consistently, seeing year over year increases in 9 of the past 10 years. Over the past decade EPS growth has annualized a strong 14%.
IBM has set a goal of $20 of per-share earnings by the end of 2015. They would need to grow EPS by about 11.65% between now and then to do that, and that’s certainly possible. If you hypothetically assign a very reasonable PE of 15 on that 2015 EPS of $20, you’d get a price of $300 per share by the end of 2015. (Which, at today’s prices, would be a 17.45% annualized return over the next 3 years, not even including dividends.)
Moreover, IBM is VERY shareholder friendly. They have reduced the number of shares outstanding by 35% over the past decade. (Roughly 4% annualized) Add in the 2% dividend yield to the 4% average buybacks, you get a very attractive amount of cash being returned to shareholders.
Going back to IBM’s extraordinary record of consistently superior profitability and growth, numerous competitive advantages, and shareholder friendly management, you’d think Mr. Market would require you to pay a significant valuation premium over the S&P 500’s current PE of 17-18, right? Luckily, that assumption would be wrong. Mr. Market will sell you his share of this wonderful business, today, at the low, low price of 12x earnings, (which is about a 30% discount to the S&P 500) and a P/FCF of about 13, which is even more attractive.
And the cherry on top? You can get an even better deal than Buffett did. Berkshire’s annual report shows that Buffett paid an average of $171.47 per share of IBM, mostly in the 2nd and 3rd quarter of 2011. That $11.6B purchase was the most money Buffett has EVER put into a single equity. IBM had a PE of about 15 at the time of the purchase, when the S&P 500’s PE was about 14. Today IBM has a PE of 12 vs 17 for the S&P 500. More importantly, IBM’s EPS has grown 24.7% since 2011, but the share price has only gone up about 8.6%. That disconnect between IBM’s intrinsic value, and its current price, is the kind of rare opportunity that I salivate over.
Bottom line: IBM is a consistent and stable profit machine, with durable competitive advantages, selling at a silly cheap price. I believe IBM will significantly outperform the S&P 500 over the long-term.
Long IBM (largest personal holding)
The company is truly global in scale, operating in over 170 counties. In addition to these economies of scale, IBM enjoys high switching costs due to very “sticky” relationships with clients. (Many of IBM’s contracts are set for 10 or more years) Consequently, IBM is so ingrained in global business and technology services that it would simply cost too much for many companies to switch away from IBM. Additionally, IBM has an extremely valuable brand. The brand is valued at 4th in the world by Interbrand. http://www.interbrand.com/en/best-global-brands/2013/Best-Global-Brands-2013.aspx These competitive advantages existing in combination (scale, high switching costs, and a formidable brand) creates an exponentially stronger business than one that only had one or two of these advantages.
Next, we’ll examine some quantitative evidence of these competitive advantages at work. The first thing that jumps out is IBM’s consistently outstanding returns on shareholder equity. The 10 yr avg is 50% and, incredibly, steadily increasing. It was 65% for 2010, 75% for 2011, and an insane 85% for 2012. That level of profitability puts IBM in the top 2 or 3% of all publically traded American businesses.
IBM has also grown per-share earnings remarkably consistently, seeing year over year increases in 9 of the past 10 years. Over the past decade EPS growth has annualized a strong 14%.
IBM has set a goal of $20 of per-share earnings by the end of 2015. They would need to grow EPS by about 11.65% between now and then to do that, and that’s certainly possible. If you hypothetically assign a very reasonable PE of 15 on that 2015 EPS of $20, you’d get a price of $300 per share by the end of 2015. (Which, at today’s prices, would be a 17.45% annualized return over the next 3 years, not even including dividends.)
Moreover, IBM is VERY shareholder friendly. They have reduced the number of shares outstanding by 35% over the past decade. (Roughly 4% annualized) Add in the 2% dividend yield to the 4% average buybacks, you get a very attractive amount of cash being returned to shareholders.
Going back to IBM’s extraordinary record of consistently superior profitability and growth, numerous competitive advantages, and shareholder friendly management, you’d think Mr. Market would require you to pay a significant valuation premium over the S&P 500’s current PE of 17-18, right? Luckily, that assumption would be wrong. Mr. Market will sell you his share of this wonderful business, today, at the low, low price of 12x earnings, (which is about a 30% discount to the S&P 500) and a P/FCF of about 13, which is even more attractive.
And the cherry on top? You can get an even better deal than Buffett did. Berkshire’s annual report shows that Buffett paid an average of $171.47 per share of IBM, mostly in the 2nd and 3rd quarter of 2011. That $11.6B purchase was the most money Buffett has EVER put into a single equity. IBM had a PE of about 15 at the time of the purchase, when the S&P 500’s PE was about 14. Today IBM has a PE of 12 vs 17 for the S&P 500. More importantly, IBM’s EPS has grown 24.7% since 2011, but the share price has only gone up about 8.6%. That disconnect between IBM’s intrinsic value, and its current price, is the kind of rare opportunity that I salivate over.
Bottom line: IBM is a consistent and stable profit machine, with durable competitive advantages, selling at a silly cheap price. I believe IBM will significantly outperform the S&P 500 over the long-term.
Long IBM (largest personal holding)
Thank you for reading!
