Investment Thesis

IBM (IBM) understandably continues to frustrate shareholders. But I argue that we should use the frustration of other investors to our advantage. IBM is trying to pull every lever it can to remain relevant in a highly competitive space. Nevertheless, when all is said and done, IBM remains highly free cash flow generative and dirt cheap.

Recent Developments

I have always asserted that IBM's shareholders should not be invested in IBM for its dividend. That to a dividend investor, one should be invested in other sorts of businesses.

IBM is a tech stock, so it's under the mercy of rapidly changing technology to drive its core operations. Next, being a dividend investor in IBM builds the wrong sort of temperament from investors.

Those dividend seekers, chasing a 5% dividend only to see the stock sell off more than 10% in a short period of time, will leave shareholders feeling frustrated and disenchanted and inclined to sell out of IBM.

Those dividend seekers, chasing a 5% dividend only to see the stock sell off more than 10% in a short period of time, will leave shareholders feeling frustrated and disenchanted and inclined to sell out of IBM.

The Warren Buffett Argument

So many IBM investors comment on Warren Buffett's (NYSE:BRK.A) (NYSE:BRK.B) investment in IBM, and the fact that he sold out of his position as validation for them now throwing in the towel. But I contend that we should put into perspective Buffett's investment.

Buffett had bought into IBM in 2011 at roughly $170.

At that time, IBM's revenue was close to $107 billion compared with the trailing twelve months of roughly $80 billion. Furthermore, while gross margin has slightly expanded since 2011, its GAAP gross margin has ended the trailing twelve months lower than at any time since Buffett's investment.

In summary, with the benefit of hindsight, which always helps when investing, Buffett evidently overpaid for IBM. Having said that, "this time it's different".

The Four Most Expensive Words In The English Language

As I have alluded to above, Buffett overpaid for IBM back in 2011. But the share price today is $119. Looking back at my table above, readers can see that back in 2011, IBM was generating free cash flow of $12.00 per share, yet Buffett deemed it appropriate to pay a 14 multiple, as he felt that was undervalued.

If present shareholders were to sell when IBM's multiple to free cash flow reached 14X, that would imply a valuation of $184. In other words, investors can sell at roughly the same price that Buffett was buying and pocket a return of more than 50% from IBM's present valuation.

Poor Management & Poor Visibility: You Get What You Pay For

There is no denying that years of seeing IBM's share price slowly meandering south will have taken its toll on investors. Furthermore, previously, shareholders will have accused management of not being sufficiently aligned with shareholders.

However, earlier this month, several insiders have bought into IBM. One could argue cynically that these purchases are small compared to their take-home packages, particularly in CEO Virginia Rometty's case, which I concede, it might be true. After all, Rometty has been taking home tens of millions of dollars each year.

However, Frederick Waddell and Joseph Swedish are two new directors, and their fees for being at IBM are less than $52K per year. Thus, them putting down over $230K each could be a more illustrative example.

Change Of Strategy

In my last month's IBM article titled, Don't Buy High And Sell Low, I went to great lengths to explain how the latest earnings call, Q3 2018, sounded different than its past earnings calls.

How the new CFO James Kavanaugh had noticeably pointed out that M&A could be on the cards for IBM. In that article, I wrote:

I question whether IBM is willing to make a drastic change from its previous strategy? Ultimately, I suppose IBM needs to do something, anything. The present state of affairs is not delivering any value to shareholders.

Consequently, just days after that article was published, IBM publicly announced its acquisition of Red Hat for $34 billion - or roughly 30% of IBM's market cap.

Accordingly, this new strategy is diametrically opposite to the previous stance IBM had pursued by focusing on its core "Strategic Imperatives". IBM might finally be opening a new chapter in its business life.


If you buy the same securities everyone else is buying, you will have the same results as everyone else. - John Templeton

Whenever I find myself frustrated with a stock, I think of the other investors also. If I'm frustrated with IBM's performance, it is more than likely that others are equally, if not more, frustrated with IBM. In fact, I suspect that if I'm frustrated, that means most other investors will have thrown in the towel and called it a day on IBM.

I argue in the article that a lack of patience in investing leads nowhere. To buy when others won't is challenging. But this strategy is what ultimately generates the strongest returns.

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