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There are two conditions that should make you, as a long-term investor with no intention of selling, root for stock price declines with a particular holding:

  • (1) If you decide to reinvest your dividends back into the company that pays them out, and/or
  • (2) You own a company that is currently repurchasing and retiring some of its common stock.

In the case of IBM, we are getting a chance to witness a case study in real time that shows you what happens to your ownership stake when a company gets to buy back stock at low prices.

In the past twelve months, IBM bought back almost $12 billion worth of stock, a little over $10 billion went towards reducing the share count to what it is today (the rest goes towards removing the stock used to make acquisitions as well as mopping up the stock used for executive compensation purposes).

Let's assume that IBM sticks with the status quo and retires $10 billion worth of stock per year for the next three years. How do shareholders benefit from the current lower prices?

Well, in March of 2013, IBM hit a high of $215. If the company bought $30 billion worth of stock at the $215 per share price over the next three years, the company would take 46.5 million shares off the books.

But if IBM bought back $30 billion worth of stock at the current price of $175 per share, the company would remove the holders of 57.1 million shares from the books.

As of now, there are 1,112 million shares that exist. And IBM is a company that makes $16.7 billion per year in net profits.

Because these lower prices would mean more shares are retired (57.1 million instead of 46.5 million over the next three years, based on present known factors), that 10.6 million spread represents "free money" that ends up accruing to your proportional ownership position merely because the buyback program happened at a lower price.

If IBM were to retire $10 billion worth of stock at an average price of $175 for the next three years, that means the share count would be reduced to 1,054 million shares (rather than the current 1,112 million shares that exist today). Even if IBM's profits were to stagnate-that is, no natural earnings per share growth over the next three years-that $16.7 billion in net profits would make you richer because it only has to get chopped up into 1,054 million pieces instead of 1,112 million pieces.

That means each share would rise from earning $15.01 per share today to earning $15.84 three years from now because of the company's buyback program, even if the company did not otherwise grow profits. That's a nice safety valve if the company's operational results continue to stagnate on an absolute basis, but it also provides a nice tailwind if you can couple it with, say, modest 5% annual growth due to the fact that IBM has a $141 billion service backlog that will likely convert to earnings per share and overall revenue growth at some point in the next three to four years.

I know a lot of investors are unimpressed with the current revenue numbers from IBM, and use that fact as a basis to refrain from investing in IBM. There is nothing wrong with that-there are tens of thousands of publicly traded companies you get to choose from, and you don't have to "force" an investment just because Warren Buffett (or whoever) owns stock in the company.

But I can explain why I don't find the revenue numbers daunting. When someone says that IBM has been posting disappointing revenue results for six quarters-that's just another way of saying a year and half-that's the blink of an eye! Coca-Cola (KO) disappointed investors from 1972 until the start of the 1980s. McDonald's (MCD) and Disney (DIS) were not particularly useful investments from the late 1990s through the early 2000s. Excellent companies are not always in the "on" rhythm of constant 10% annual growth, 10% annual dividend growth, and 10% annual capital appreciation. That's why you have a diversified portfolio-so different stocks take turns doing the heavy lifting.

But in the case of IBM-there can be a tendency to ignore the fact that 2011 was a very strong year for IBM's revenue numbers (when it brought in just shy of $107 billion). The year before that, revenue was at $99.8 billion. And last year, it was at $104 billion. This year, it could still very well clear the $100 billion mark. And for a really holistic perspective, it can be useful to remember that IBM's revenues were at $89 billion ten years ago. So the company's revenue is still on a general trend upwards-and I don't feel the need to act like a ping-pong ball and sell just because the revenue figures are not perfectly linear.

And incidentally, each investor's share of the revenue pie is on a steady increase upwards because of the buyback program. Take 2011, for instance-that was when IBM posted its $107 billion total revenue figures that analysts are suddenly nostalgic about. At that time, each share represented $91.92 in revenue. But because the share count is reduced, and each ownership share represents more, as we sit here in 2013 we can know that each share represents just shy of $94 per share. That's the fun part of being a current shareholder-despite the headline risk that the sky is falling with IBM, each share I own represents more earnings per share and more revenue per share than it did in 2011. People are complaining about IBM, but each share I own continues to represent more money. That's fine by me.

The share count reduction, incidentally, has been an important reason why IBM shareholders have ended up with more money in their pockets, as the dividend has increased by a little over 600% since 2000. That's because IBM only has to spread its dividend payments out over 1.1 billion shares today, rather than 1.7 billion in 2000. That's why the so-called inorganic drivers of wealth (like sharebuybacks) aren't as lame as you think-the earnings per share growth is real, and the lower number of owners makes it easier to grow the dividend and put real cash in your pocket because there are fewer ownership claims outstanding. If IBM's stock price continues to decline, the wealth-building process will continue to accelerate for the shareholders that remain. That's the great irony of this revenue miss kerfuffle.

Source: The Irony Of IBM's Buyback Program After The Revenue Miss