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Why Warren Buffett Still Loves IBM

By Andrew Tonner – Mar 5, 2016 at 6:45AM

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In Berkshire Hathaway’s recent annual letter, the Oracle of Omaha again spells out his long-term investment thesis for the lumbering, transforming enterprise tech giant.

Source: IBM

Even the great ones don't get it right every time, and Berkshire Hathaway (BRK.A 1.62%) (BRK.B 1.47%) Chairman and CEO Warren Buffett is certainly no exception.

While Berkshire Hathaway's track record is nothing short of legendary, Buffett's collection of investments contains one noteworthy black-eye for the billionaire octogenarian -- enterprise tech turnaround play IBM (IBM -0.25%).

However, in his most recent, widely circulated annual missive, Buffett again affirmed his allegiance to IBM and its long-term investment potential. So as Berkshire and Buffett eagerly wait for IBM's turnaround to take root, what can the Oracle's recent signals tell the average investor? Let's take a look.

Buffett on IBM
This past weekend, Berkshire Hathaway published the 2015 edition of Buffett's letter to shareholders. Though the sweeping discussion included discourses on fields ranging from presidential politics to economic history, Buffett still made time to touch on Berkshire's IBM holdings, which today trade for less than Berkshire paid when it first bought into the company in 2011.

Speaking of Berkshire's so-called "Big Four" investments in publicly traded firms IBM, Coca-Cola, American Express, and Wells Fargo, Buffett reiterated that each of them "possess excellent businesses and are run by managers who are both talented and shareholder-oriented." Thanks to its winning business model, increasingly cheap valuation, and emphasis on stock buybacks, Berkshire's holdings of IBM increased from a 7.8% stake at year-end 2014 to a 8.4% stake at last year's conclusion.

Looking to the future, Buffet cited the Big Four's continued use of sensible stock buybacks and internal reinvestment opportunities as key drivers, which "leads us [Berkshire] to expect that the per-share earnings of these four investees, in aggregate, will grow substantially over time" even as firms like IBM must navigate the occasional business model or product overhaul. To be sure, Buffett's ongoing confidence in Big Blue should certainly carry weight with most retail investors, but it's by no means the only winning attribute the firm enjoys at its current trading levels.

IBM: Too cheap to ignore?
Though not all parties at Berkshire are as bullish on IBM as Buffett, the century-old technology kingpin has successfully navigated several similar business model reinventions over the course of its vaunted history. And assuming IBM doesn't go the way of the dodo amid its current business reorganization, its rock-bottom valuation could make it a prescient buy for patient investors today.

At present, IBM trades at an absurdly cheap 9.6 times trailing earnings. What's more, IBM's dividend yield tops 4%, which could make its stock particularly enticing for income-seeking investors. For context, the S&P 500's price-to-earnings ratio currently sits at 21 times, and the index's 2.2% dividend yield similarly falls well short of IBM's payouts.

That being said, it also bears mentioning that the discount on IBM isn't entirely without justification. As it shifts away from its long-standing three-pronged business model to one largely predicated on cloud computing, big data analytics, and other emerging enterprise tech growth industries, IBM has endured protracted top-line pressure. As of its most recent earnings report, Big Blue's sales have now declined for 15 straight quarters on a year-over-year basis. Thanks to IBM's deft use of share repurchases, its sales declines have largely failed to impact the firm's profits per share .

The key point here is that IBM's outlook does include some business risk, and any investor considering its stock must seriously weigh the risk-reward equation before purchasing. However, as Buffett reiterated in his recent letter to Berkshire shareholders, IBM's shares today offer a tremendous value for investors who believe the firm will indeed survive its business model transition.

Andrew Tonner has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Berkshire Hathaway. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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