If you are currently an IBM (IBM) shareholder or are contemplating a purchase in the information technology giant, there are likely two issues of importance in your current analysis of the company's future prospects:
- Does the decline in the company's share price, from a high of $215 around St. Patrick's day this year to under $176 now represent the wisdom of the crowds, or is it representative of Mr. Market's folly that Benjamin Graham warned us about?
- Is the company's declining revenue ($1 billion miss, says the Street!) a controlling factor in determining whether an IBM investment will likely be a profitable source of wealth creation for shareholders with a long-term orientation?
To answer the first question, it can be useful to start by looking at IBM's trading history to see whether it has historically been profitable for the stock price to fluctuate wildly while creating wealth over the long term.
When we look at IBM's most recent thirteen-year trading history, the general rule we can learn is that IBM's short price fluctuates wildly even as it creates wealth over the long-term that outpaces the general performance of the S&P 500 at large.
Let's look at a few examples of that general truism. In 2001, IBM hit a high of $124.70. The next year, it hit a high of $126.39. Over the course of 2002, the company's share price hit a low of $54.01. This cause of this decline was likely IBM's overvaluation in the closing days of the tech bubble, mixed with a modest decline in business performance marked by annual profits that declined from $4.45 in 2001 to $4.03 in 2002 to $4.43 in 2003.
IBM did not again cross its 2002 high until 2008 (when the price briefly crossed the $130 mark), which was a year that again marked IBM's price slide that accompanied The Great Recession. After topping out at $130.93 in 2008, the price of the stock fell to $69.50 over the duration of the rest of the year, proving Charlie Munger's adage that a long-term investor should be prepared to see his holdings fluctuate by 50% over long-term holding periods because rough economic patches and irrationally low prices (resulting from fear about the future) are commonplace over the course of an investing lifetime.
Yet, despite these occasions for wild price swings, IBM has been a much more predictable company when it comes to creating long-term shareholder wealth.
Since 2000, with dividends reinvested, IBM has returned 7.7% while the S&P 500 has returned 3.7%.
Since 2002, with dividends reinvested, IBM has returned 9.9% while the S&P 500 has returned 8.1%.
Since 2004, with dividends reinvested, IBM has returned 9.1% while the S&P 500 has returned 5.6%.
Since 2006, with dividends reinvested, IBM has returned 11.9% while the S&P 500 has returned 4.3%.
Since 2008, with dividends reinvested, IBM has returned 19.9% while the S&P 500 has returned 15.6%.
Those figures represent annualized performance. IBM's long-term impressive performance in relation to the S&P 500 is especially impressive considering that: (1) its performance from 2000 through today took into consideration grosser overvaluation due to the tech bubble than the market experienced as a whole (I mean this on an intrinsic value, not P/E basis), and (2) the long-term results represent IBM's current price, which is likely irrationally deflated from where it should be and will be several years from now.
In that regard, we can conclude that IBM's share price has not been a meaningful indicator of true worth over the past thirteen years (likely due to pessimistic predictions about the company's future that failed to materialize), and we should try to determine whether the current price decline is yet another iteration of this trend or a true cause for concern.
The answer to that question is likely tied up in the second issue-does IBM's current pattern of declining revenue mark a permanent deterioration in the company's business model that should cause its shareholders concern?
The short answer is no.
The longer answer is that it is important to realize that IBM's share count reduction (as the result of its buyback program) is a way to stimulate earnings per share growth even absent revenue growth for the company as a whole (basically, IBM's capital allocation policy equips the company to make you richer without increasing the size of the overall pie because the buyback program buys out other shareholders with claims on the pie, allowing you to have a bigger slice of the pie that is generally staying the same size or modestly shrinking). That is a nice safety valve for shareholders interested in getting wealthier even during the company's difficult periods of business performance.
The latter three companies have all experienced extended periods in the past thirteen years where the headline risk did not reflect the company's profitability. Johnson & Johnson gets ragged on with its constant stream of recalls, yet it increased per share profits from $4.15 in 2007 to an estimated $5.46 this year ($5.10 as of 2012). McDonald's became a form of synecdoche for America's obesity crisis in 2003, yet per share profits increased from $1.32 in 2002 to $1.93 in 2004, evincing the fact that headline risk does not necessarily hit the balance sheet. And in the case of Microsoft, despite a constant barrage of criticism, the company has managed to grow earnings by 11.0% annually over the past ten years.
For me, the decision to stick with (and continue to purchase) shares of IBM has been easy because the headline risk has not hit the company's earnings figures. Investing during The Great Depression or the 1973-1974 bear market was hard because corporate profits fell 25-50% (depending on the company), forcing investors to make determinations about whether declining earnings indicated permanent impairment. IBM isn't even putting me in the position to make that judgment call-the earnings per share continue to increase.
IBM is likely going to make somewhere north of $15 per share in profits this year (for instance, the Value Line estimate is $15.10). In 2012, IBM posted $14.37 in profits per share. As a shareholder, there is a realistic chance that each share of ownership will represent 5% more in profits at the end of this year than it did at the end of 2012. The dividend continues to go up. Despite the headline risk, my proportional share of the enterprise is actively increasing at this very moment. Despite the headline risk, each share I own will represent more profit this year than it did last year-IBM is not even requiring us to make a determination about business impairment at this point.
Blotchy revenue performance is nothing new to IBM shareholders. It fell $5 billion between 2004 and 2006, as earnings per share increased from $5.05 to $6.01. It fell $4 to $8 billion during The Great Recession and its immediate aftermath, and earnings per share climbed from $8.93 in 2008 to $11.52 in 2010. Declining revenue, mixed with earnings per share growth, has been a part of IBM's long-term "story." And that is a story that has often produced wealth superior to that of the S&P 500 Index components, as I outlined above. The trouble in the Asian markets has been long forecast, and a troubled growth platform (on the global scale) has not been enough to prevent IBM from increasing profits per share.
Considering that IBM's backlog is growing, and considering that net profits are actually expected to increase to $16.7 billion this year, I am content to not only continue to hold my IBM stock, but add more if the price remains below the $188 mark. If I let short-term business disappointments derail my strategy, I wouldn't consider myself cut out for long-term investing. I don't abandon a strategy in response to short-term business challenges (in fact, I regard those as a buying opportunity). Considering that my share of the profits is actually increasing on an annualized basis, I find this decision easy--I feel quite comfortable ignoring headline risk so that I can use this earnings miss as an opportunity to participate in the "buy low" philosophy that intelligent investors recommend in the textbooks.