Although simply oozing with irony in this application, investors large and small can learn a lot from Warren Buffett's widely mentioned and eminently true investing maxim, "Be fearful when others are greedy, and be greedy when others are fearful."
Although short time frames have never been to his taste (and rightfully so), the performance of IBM since the time Buffett's Berkshire Hathaway began purchasing its stock in mid-2011 has dramatically underperformed the market as a whole.
However, Buffett has made a career from exploiting myopic investors and traders, and I've become increasingly intrigued with IBM's stock as a potential contrarian value pick in a market offering increasingly fewer obvious buying opportunities.
The case to buy Big Blue
While IBM has done so before, this investing thesis is almost entirely predicated on IBM's ability to navigate its current and sizable corporate reorganization. For too long, IBM rested on a consistently and undeniably lucrative business strategy of selling enterprise IT hardware and software, which in turn led to sizable consulting contracts, too. However, in an era in which cloud computing de-emphasized the need for the on-site data center, IBM's long-running strategy has quickly became untenable, as evidenced by the company's revenue declining in each of its past 14 consecutive quarters.
Although it remains early in the phases of its cloud, mobile, and big data pivot, signs of progress are beginning to manifest in IBM's financial results. For its entire 2014 fiscal year, IBM reported $7 billion in cloud revenue. However, at its most recent earnings release, IBM disclosed that cloud revenue had grown to a $9.4 billion run rate over its last four quarters. With IBM's total revenue over the same four quarters sitting north of $81 billion, IBM's new growth initiatives like the cloud will need to meaningfully expand in order to substantially bolster the company's financial performance.
However, the lack of acknowledgement from the market that any progress is being made is the key point, here. Here's a quick snapshot of IBM's valuation relative to a few of the market's most important indices.
|
IBM |
Dow Jones Industrial Average |
S&P 500 | |
|---|---|---|---|
|
Price-to-Earnings Ratio |
9.8x |
16.7x |
21.9x |
|
Dividend Yield |
3.6% |
2.5% |
2% |
Sources: Professor Robert Schiller, Yahoo! Finance, WSJ data.
Hopefully, this should be a fairly self-evident point, but IBM is absurdly cheap. Trading around its five-year lows at present valuations, and with its well-defined turnaround strategy already bearing fruit, it seems to me that now could prove one of those special moments in investing when the market has failed to fully appreciate a change happening before its very eyes. These moments tend to prove transitory, though, and it's also worth noting that the odds of this scenario playing out exactly as articulated are low.
Not out of the woods yet
To be sure, any investor interested in further pursuing this idea needs to be convinced that IBM's restructuring plan will indeed bear meaningful fruit. If IBM and CEO Ginni Rometty can't make good on this historic strategic shift, then IBM as we know it could find itself in serious trouble. As one of the best-capitalized and well-run companies in American corporate history, the odds of this seem relatively slim, but given the move's importance to this specific investment thesis, it bears consideration.
Beyond that, IBM also recently disclosed that it's being investigated by the Securities and Exchange Commission (SEC) for some portion of the company's revenue recognition practices. Although the analyst community doesn't necessarily believe the news will prove material for IBM's long-term outlook, it did help send IBM stock down 4% on the day the news broke.
However, should these risks fail to be significant, investors with the foresight and patience to buy into IBM, even as the market as a whole hates it, could stand to benefit significantly from its eventual comeback.
