If it weren’t for oil stocks, as well as my recognition that there are quite a few companies with superior growth rates worth mentioning, I would spend a lot of time talking about just how cheap IBM has gotten in the past two years (and also bring home the point that Benjamin Graham, David Dodd, and Warren Buffett were right when they said that true value investing is not something many people are going to be able to practice in real life because companies can remain cheap for quite a few years, and heck, Abbott Laboratories spent most of the 2000s trading at a discount before the rapid rise in the value of healthcare stocks at the same time that Abbott Labs was spinning off Abbvie). Buffett, personally, chose to get around this point by owning operating companies that gave him regular profits to invest in the stock market, so that stocks acted as a place for him to inventory his profits from his main business. In my writing here, I get around this tendency by focusing on companies that pay a dividend (preferably one that grows every year) so that you at least get paid to wait for the stock to reach a fair price and can benefit from the added wealth that results from reinvested dividends at low prices.
In the case of IBM specifically, I find it wild that people are going nuts over a company that, despite all of the criticism against it, continues to make $15 billion in annual profit and rank among the four dozen most profitable companies in the entire world. IBM now trades at less than 10x profits, and a 2.7% dividend yield, which puts the company at its cheapest valuation level since the last recession in early 2009.
What I take seriously when I study companies is how it performed during the last recession, and then I compare whether similar conditions exist as it works its way through its own current problems. What most people have already forgotten is that IBM saw its profits per share grow from $8.93 in 2008 to $11.52 in 2010 because even though the business was having trouble growing, the stock buyback at 9-11x earnings was so significant that profits per share increased substantially in spite of the mediocre actual performance. From the perspective of shareholder enrichment, the force of the buyback was stronger than the force of treading water business performance, and so wealth got created.
That is happening right now as well: Because IBM sold its semiconductor business, paid substantial packages to senior employees to induce early retirement, and saw demand for its global technology division stagnate, IBM saw its actual profits go from $16.4 billion to $15.1 billion. Despite this bad year, earnings per share actually increased from $14.94 to $15.00. The ability of the company to repurchase stock in the $170s, $160s, and now, $150s, has been a stronger countervailing force than the roughness of profit growth in the past year.
Donald Yacktman once said that his favorite investments are those that only require a little bit to go right in order for good things to happen because he learned that low expectations for high-quality companies is a nice forward-looking way to create wealth. In the case of IBM, the expectations are extraordinary low: I am very surprised to see a stock worth around 14-16x earnings trade at 9-10x earnings absent a widespread recession. The reason is because revenues and actual profits across the business haven’t been growing the past 2-3 years, even though profits per share have. When you see an uptick in revenues and companywide profits, suddenly the effect of the repurchased stock here in 2013, 2014, and 2015 will have even more significance as the profit growth will only have to be shared among a smaller number of owner-claimants entitled to a share of dividends, capital gains, and the overall IBM pie.
The good thing about this current stock market is that it’s a safe playground of sorts for people to figure out their identities and emotional tolerances as investors. If someone is bothered seeing IBM go to $199 to $158 in the past year, or Chevron go from $135 to $110, or Royal Dutch Shell go from $88 to $66, then they paid relatively cheap tuition to learn that certain sectors of the economy, and perhaps stocks in general, are beyond their emotional risk tolerance zone and they would be better off owning treasury bonds or cash-generating assets without daily quotations like actual real estate. It’s better learn that now when the stock declines are relegated to a few sectors and specific businesses, and the actual declines are modest compared to what the United States has experienced in the past 100 years. If you’re getting worried now, you might be in the wrong game. If you’re putting in buy orders for shares of Royal Dutch Shell at $66, you’ve probably got value investing in your brain and DNA, and over long periods of time, that gene will make your life much easier than it would otherwise be.
Originally posted 2015-01-09 01:47:56.