Why Buffett Still Stands by His Investment in IBM... - The 5 Minute WrapUp by Equitymaster
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Why Buffett Still Stands by His Investment in IBM...

Nov 27, 2015
In this issue:
» QIP rush fading away?
» How serious can warning letters be?
» ...and more!
0:00
Radhika Nabar, Managing Editor of ValuePro

The legendary investor once famously stated that he is not comfortable investing in technology stocks. The reason? The changes in the industry are too rapid and hence unpredictable. And unpredictable businesses lie outside Buffett's circle of competence.

So he avoided tech stocks for a long time. Thus, in 2011 when he purchased a stake in IBM, not surprisingly, several eyebrows were raised. What made him change his mind?

Now Buffett had been studying IBM for some time. According to him, the clarity expressed in the company roadmap about where it was headed and what it was planning to do convinced him to put his money in the company.

However, since the time Buffett purchased a stake in IBM, the stock has failed to deliver. As reported in an article in InvestorPlace, in 2011, IBM's stock was trading at around US$170 per share. At the time, it was considered a real steal. Four years later, the stock has fallen to around US$140 per share. Clearly, Buffett has not been making money from this investment.

And yet, Buffett is not yet ready to label this a mistake. Instead, he still stands by IBM. Why is that?

One is that back then he bought the stock at a sufficient margin of safety. And even if the stock price has tanked, the dividend yield is around 4%, which means that the overall return may not necessarily be that bad.

But more importantly, Buffett is impressed by how the company focuses on facilitating efficiency. According to him, improving efficiency and productivity is critically important to economic growth.

Basically, IBM is focused on areas that help streamline the way the world's companies, institutions, research centers, and universities function.

Indeed, in one of our recent editions of the 5 Minute WrapUp, we talked about how low-cost advantage is also a very important economic moat besides brand power.

One way to achieve this is through processes. Process-based cost advantages accrue through efficient and cheaper production or supply processes. The idea is that, in building better processes, a company can provide its products and services at a cheaper price compared to its peers.

So IBM is involved in the business of improving the productivity for other companies across sectors.

Indeed, Buffett's statements on the importance of productivity make a lot of sense. In fact, our ValuePro portfolios also boast of a few tech stocks that have done well because of their focus on productivity, thereby raising the potential to increase shareholder wealth in the longer run.

IBM is facing rough weather now. But, considering how long Buffett likes to hold stocks, there's still plenty of time for him to have the last laugh.

Do you think that efficient and productive companies ultimately deliver stronger returns in the long term? Let us know your comments or share your views in the Equitymaster Club.

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3:03 Chart of the day

During 2014, in the immediate post election period, as the euphoria fuelled the Indian markets, the fund raising activity also gained momentum. Take the case of money raised by the listed companies via qualified institutional placement (QIP). The funds raised during this period were at a peak in the last couple of years.

However, since then, volatile market forces have weakened the fund raising activity from this group.

QIP rush fading away?

According to us, this is the classic example of market exuberance, largely driven by sentiments rather than fundamentals. Companies then were carried away by the post general election enthusiasm.

However, as the dust settled down, things have not been hunky dory. Companies have been witnessing disappointing growth almost every quarter. Further, as reported in Business Insider, even the festive season did not really do much in terms of boosting demand. Reportedly, according to the Deutsche Borse's MNI India Business Sentiment Indicator, the business sentiment fell to the lowest level since February 2014, and companies are seeing little possibility of recovery in the coming months. With demand coming under pressure, the scenario is unlikely to improve, atleast in the near term.

Expectations that the new government will improve business environment led corporates to expand their balance sheets. However, the demand has not picked up at the expected pace. Besides global factors, domestic issues on economic and political fronts have clouded investor sentiment. Keeping in mind the current state of affairs, it will be difficult for companies to raise money.

4:01

Regulatory challenges have been an issue for pharma companies since some time now. These aspects have kept the stock prices of various pharma companies on the edge. Fresh in the line of fire is Dr Reddy's Laboratories. The stock tumbled by almost 15% in a single day, after the company announced three of its facilities receiving a warning letter early this month. The stock has continued to remain under pressure since then.

Yesterday, the stock corrected by another 10% after the warning letter issued to the company was made available on the USFDA website. The letter highlighted lack of compliance on various fronts, and indicated the regulator was not satisfied with the company's earlier responses.

Given these issues, market participants seem to be speculating on two fronts. First, can the issues worsen from these levels? This means the company getting an import alert. In such a scenario, not only will the company not get new approvals from those facilities, but it will be banned from exporting existing drugs as well. Second, if things do not worsen, how long will the company take to resolve the issues mentioned in the warning letter?

An article in the Business Standard has listed some companies and the time taken by them to resolve warning letter issues.

Time taken historically to resolve warning letters

The above data highlights that the time taken by a company to resolve the issues could vary from a few months to a couple of years. This depends on a few factors. First, the seriousness of issues in the facilities. Second, the management's ability and experience to deal with such issues.

In the case of Lupin, the company was able to resolve its warning letter issues in around 7 months, while others took some more time. Hence, it is difficult to estimate the time that will be taken by Dr Reddy's to address its problems. Further, it must be noted that the company has to address issues at three facilities, and these will be different across each. Hence, the clearance might happen gradually and not at one go for all the facilities.

4:45

After opening firm, the Indian equity markets have continued to gain momentum. At the time of writing, BSE Sensex was trading higher by 104 points and NSE-Nifty was trading up by 32 points. Both mid cap and small cap stocks too inched upwards and were trading higher by 0.2% each. Gains were largely seen in banking and metal stocks.

4:55 Today's investment mantra

"We enjoy the process far more than the proceeds" - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Radhika Pandit (Research Analyst) and Bhavita Nagrani (Research Analyst).

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1 Responses to "Why Buffett Still Stands by His Investment in IBM..."

Skand Bhargava

Nov 28, 2015

Just because it was purchased by Buffett, you are desperately trying to justify his call to buy IBM. Had I purchased the same stock (and not Buffett), you would have been telling me why I should have listened to your advice.

My point: Don't be afraid to criticise Buffett when he is wrong. Our heroes make mistakes too. Right now you are acting just like die hard AAP and BJP followers, who never find a wrong in their own party, till one of their own leader apologises.

Tomorrow if Buffett leaves this company, what will you have to say? That Buffett is making a mistake?

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