Why Buffett’s IBM Buy Is a Sell Signal for Tech Stocks

by Jamie Dlugosch | November 28, 2011 7:00 am

Why Buffett’s IBM Buy Is a Sell Signal for Tech Stocks

Does Warren Buffett’s IBM[1] (NYSE:IBM[2]) buy — his  first real foray into tech stocks — portend the wizard’s purchases of other big tech stocks like Apple (NASDAQ:AAPL[3]), Google (NASDAQ:GOOG[4]) or Hewlett-Packard (NYSE:HPQ[5])?

If so, here’s a contrarian suggestion: Perhaps investors should be selling these names and other tech stocks.

When Buffett announced that his Berkshire Hathaway (NYSE:BRK.A[6]) holding company would buy its own shares, I wrote about the buyback being an example of his Golden Rule of investing[7]. Specifically, Berkshire will buy shares as long as the price doesn’t exceed 110% of book value.

Buffett’s IBM purchase, however, blows this fundamental approach to buying stocks out of the water. Forget for a moment that IBM is trading near its all-time high. This stock is no value play. IBM now trades for almost 10 times book value. That’s far from the Golden Rule of buying a stock trading for just over book value or less.

You can view Buffett’s buying of IBM two ways. On one hand he’s to be commended for dipping into a sector he has long ignored, yet has generated significant returns for investors. In IBM he made a solid choice. Big Blue is a winner. It has consistently increased earnings over the years and shows no signs of slowing.

But things can change quickly in technology. One could argue that the time to buy IBM was a year or two ago. And many critics indeed suggest that the old man has lost his way. They’re right to question Buffett’s obvious change in strategy, even if this deal is the exception rather than some new way of managing Berkshire’s money.

I’m a contrarian at heart, and I’m in the critics’ camp. It really looks like Buffett’s late to the game and diving into a stock at the wrong time. IBM shares are expensive, and one could argue that with a recession likely, they’re a money-losing proposition.

I’d even go as far as saying Buffett’s departure is a signal to sell technology stocks. Here are two big names I would dump:

Hewlett-Packard

One reason to be skeptical of Buffett’s IBM buy is the outlook for technology stocks in 2012. Shares of Hewlett-Packard fell after the tech giant offered a lackluster forecast for the coming calendar year. HP’s troubles go far beyond next year’s forecast. HP has made several missteps that cloud the future.

Earnings aren’t so bad: For the quarter ending Oct. 31 HP made an adjusted profit of $1.17 per share, versus analysts’ forecast of $1.13. The trouble is the future.

For the next quarter ending Jan. 31, new CEO Meg Whitman is setting the bar low, with a estimated profit of 83 cents to 86 cents per share, versus the average analyst estimate of $1.11.

HP is clearly being cautious. Investors should be cautious, too.

Apple

I wouldn’t buy Apple at $400 per share. Having bought IBM, Buffett most certainly would consider a purchase of Apple. In fact one could argue that Apple is a better value than IBM, but clearly we aren’t talking about value here.

Instead, we’re judging a possible paradigm shift by of one of the most successful investors ever. On those grounds, I would be a seller of Apple if Buffett is a buyer.

Even with Apple trading at $368 as of Wednesday, the stock still might be too pricey. In the last quarter ending Sept. 30, the company missed earnings estimates for the first time. It’s just one miss, but what if it becomes a trend? Add in the death of Steve Jobs, and you have plenty to worry about.

The competition is gunning for Apple this holiday season with similar products and lower prices. Apple will fight back for sure, and its brand equity gives it a huge advantage. But it’s no given that Apple can sustain its dominant leadership forever.

Endnotes:
  1. Warren Buffett’s IBM: http://investorplace.com/2011/11/warren-buffett-berkshire-hathaway-ibm-stock/
  2. IBM: http://studio-5.financialcontent.com/investplace/quote?Symbol=IBM
  3. AAPL: http://studio-5.financialcontent.com/investplace/quote?Symbol=AAPL
  4. GOOG: http://studio-5.financialcontent.com/investplace/quote?Symbol=GOOG
  5. HPQ: http://studio-5.financialcontent.com/investplace/quote?Symbol=HPQ
  6. BRK.A: http://studio-5.financialcontent.com/investplace/quote?Symbol=BRK.A
  7. the buyback being an example of his Golden Rule of investing: http://investorplace.com/2011/09/warren-buffett-berkshire-hathaway-stocks-to-buy/

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