International Business Machines Corp. (NYSE:IBM) shares have endured a rollercoaster ride in 2017, rallying nicely during the early part of the year before embarking on a precipitous decline. IBM stock hit a 52-week peak of $182 in early March, but now sits near $152. Weak QI earnings as well as Berkshire Hathaway Inc.’s (NYSE:BRK.A, NYSE:BRK.B) sale of more than 30% of its position in IBM stock have been weighing heavily on Big Blue.
International Business Machines is down 8.5% in the year-to-date, a sharp turnaround in fortune compared to 2016 when it finished the year with an impressive gain of 20.6%.
Warren Buffet Sours on IBM Stock
Berkshire’s Warren Buffett has been one of the biggest cheerleaders for IBM stock ever since he picked up his first batch of IBM shares back in 2011. Up to that point, the legendary investor had been indifferent to tech stocks, terming them ”too unpredictable.” But when he finally jumped in, he bet the farm by purchasing 45 million International Business Machines shares at $159 a pop. He gradually continued building his position in Big Blue, and held 81 million shares by the end of 2016, good for 8% stake in the company.
Buffett has always favored investing in companies that he understands well, with strong management teams and when the shares are trading with a good safety margin. So what exactly triggered his interest in IBM?
Two things: low share price and good earnings potential. In the not-too-distant past, Big Blue relied heavily on copious buybacks as a means to prop earnings and create good shareholder value. During the first three years after Warren Buffett’s first purchase, Big Blue managed to repurchase 20% of its shares, which helped keep earnings healthy despite the company remaining in the throes of a revenue tailspin.
Fat dividends were another big draw. IBM stock is nearing dividend aristocrat status having paid out dividends for more than 100 years and increased payouts over the past 21. Long-term investors like Buffett who reivested all their earnings and dividends realized decent returns on their IBM investment, even when the stock price failed to go anywhere.
But Buffett’s love affair with International Business Machines did not last very long. The man is known for holding stocks for what seems like an eternity. Selling more than a third of his stake after ”just” six years does not inspire a lot of confidence in IBM stock.
No Easy Pickings for International Business Machines
It’s not hard to see why IBM stock has lost some of its allure for Mr. Buffett. IBM finally slammed the brakes on its massive buybacks, and instead focused on investing the cash in growth areas such as the cloud and the Internet of Things. This has had a rather dramatic impact on the bottom line: Big Blue reported nearly flat earnings-per-share growth for the first-quarter, a far cry from the trend three years ago when the bottom line was expanding in the mid-teen percentages.
With minimal buybacks and flat earnings, investors like Buffett were bound to lose interest in the stock. Here’s what Buffett said about selling a huge chunk of his IBM stake: “I don’t value IBM the same way that I did 6 years ago when I started buying … I’ve revalued it somewhat downward … When it got above $180 we actually sold a reasonable amount of stock.”
He also added that International Business Machines now has plenty of big competitors. It’s also worth noting that Berkshire’s cost basis for its entire IBM stake works out to $170 per share, considerably higher than current share price.
The Case for and Against IBM Stock
Mind you, Buffett still owns 50 million shares of Big Blue and has stopped selling. While that does not bear mentioning in the same breath as his recent purchase of an additional 72 million Apple Inc. (NASDAQ:AAPL) shares, it obviously means that he still sees some value in IBM stock.
So maybe it’s time for investors to apply one of Buffett’s famous aphorisms to International Business Machines: be fearful when others are greedy and greedy when others are fearful.
That’s an admonition to consider taking a contrarian view on stocks that you believe have more intrinsic value than what the market has assigned them. Maybe it’s not such a bad idea that IBM stock has lately swooned because it offers long-term investors fresh entry points. After its recent move, IBM stock trades at just 11 times 2017 expected earnings and yields a juicy 4%. Future dividend growth appears feasible for years due to the low payout. Further, the stock has been grinding higher over the past few days and it is showing a bullish reversal signal.
Long-term investors though will have a hard time loving the stock of a company that has seen revenue declines for 20 consecutive quarters. In fairness, the decline seems to have moderated over the past few quarters due to impressive growth in its Strategic Imperatives segment. But serious doubts still linger about the company’s ability to complete another turnaround. IBM managed to come out of near-oblivion in the early 90s, but it might find the decks stacked against it this time around.
Ultimately, IBM stock might only be worth the while for patient long-term investors who don’t mind waiting for the company to reinvent itself. That was my verdict in 2015, and little of significance has changed since then.
As of this writing, Brian Wu did not hold a position in any of the aforementioned securities.
