IBM According To Warren Buffett's Annual Letters To Shareholders

| About: International Business (IBM)

Summary

IBM meets Buffett's strictest test for economic excellence, a Fortune Return on Equity study he cited in his 1987 letter.

Buffett's IBM purchase price was ~10x Pre-Tax earnings, a price guideline he has adhered to in several past purchases, as summarized in my article.

IBM's current share price has an embedded growth assumption of only 1.5% a year as investors and the financial media are very bearish on IBM.

Academic research has shown that investors will earn better returns by focusing on stocks that have very low expectations for growth according to analysts.

IBM earns high profit margins, and profit margins are "The Ultimate Source of Investor Returns," as they are both persistent and predictable.

Warren Buffett and IBM

"Face up to two unpleasant facts: the future is never clear and you pay a very high price for a cheery consensus. Uncertainty is the friend of the buyer of long-term values."

-- Warren Buffett; CEO of Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B) Forbes Magazine Article

"The other thing I would say about IBM, too, is that a few years back they had 240 million options outstanding, now they are down to about 30 million. They treat their stock with reverence, which I find is unusual among big companies. Or they really...they really are thinking about the shareholder."

-- Warren Buffett, CNBC November 14, 2011

The investing media and individual investors are consistently asking the question: "What could Warren Buffett possibly see in a company like IBM?" And instead of studying Buffett's annual reports or looking at past acquisitions he has made for clues, the investing media seems to just give up on doing any research and concludes that the IBM purchase is some type of rare anomaly from a bad Warren Buffett Coca-Cola bender.

In reality, the IBM acquisition is "Classic Buffett," as Charlie Munger stated (Of Permanent Value, Volume 1 of 3), and I'll explain why the IBM acquisition is classic Buffett in using Buffett's yardsticks for return on capital, purchase price, capital allocation, and management quality as discussed in his letters to shareholders and at the annual meetings in Omaha. In addition, I will examine current investor and analyst sentiment on IBM and see if the company presents an opportunity in terms of some of the behavioral investing parameters emphasized by Buffett over the years.

Buffett Metric #1: Return on Equity and Return on Invested Capital -- 1987 Fortune Magazine Study

"The Fortune study I mentioned earlier supports our view. Only 25 of the 1,000 companies met two tests of economic excellence - an average return on equity of over 20% in the ten years, 1977 through 1986, and no year worse than 15%. These business superstars were also stock market superstars: During the decade, 24 of 25 outperformed the S&P 500."

-- Warren Buffett; 1987 Letter to Shareholders

"Over the long term, it's hard for a stock to earn a much better return that the business which underlies it earns. If the business earns six percent on capital over forty years, you're not going to make that much different than a six percent return - even if you originally buy it at a huge discount. Conversely, if a business earns eighteen percent on capital over twenty or thirty years, even if you pay an expensive looking price, you'll end up with one hell of a result."

-- Charlie Munger; Vice President; Berkshire Hathaway (BRK.A, BRK.B)

Both Warren Buffett and his partner Charlie Munger have stressed the importance of returns on capital earned by a company, especially a company a potential investor is looking at for investment purposes over a long period of time. High returns on capital are also the single best indicator of a company with a wide business moat or significant competitive advantage according to Buffett and that is the type of company Buffett and Munger covet most since their shift to purchasing high-quality businesses with the acquisition of See's Candies in 1972 for $25 million.

In his 1987 Berkshire Hathaway letter to shareholders, Warren Buffett described the ultimate test of economic excellence for a company and its management. In the letter Buffett mentioned a Fortune magazine study documented in their 1987 annual investment issue regarding long-term returns on equity experienced by the 1,000 largest companies in the previous 10-year period.

The requirements of the test were so difficult that only 2.5% of the largest 1,000 companies passed the test. The test contained two simple criteria: 1) an average return on equity of 20% per year for the previous 10 years, and 2) No single year in the ten-year period where return on equity was below 15%. When looking at prospective investments, I often see how the company measures up according to this very difficult test, and few pass it. Based on my past research, I know that longtime Buffett protégé Ted Weschler favorite Davita (NYSE:DVA) passes the test, but it would be interesting to see how other Berkshire investments measure up, particularly IBM.

IBM's long-term financials on the Value Line Investment Survey website show that the company has consistently been able to earn extremely high returns on equity and on invested capital. In fact, as of 12/31/13, IBM's return on equity is good enough to pass the Fortune test of economic excellence mentioned above. For the 10-year period ended 12/31/2013, IBM's average return on equity was 59.7% (significantly above 20% hurdle) and there was no individual year where return on equity was less than 15%.

Incredibly, IBM's return on invested capital actually passes the test as well. For the 10-year period ending 12/31/13, average return on total capital was 29.7% (9.7% over 20% hurdle) and no individual year was below 15%. Considering the statistics Buffett mentioned (25 out of 1,000 passed), this was an incredible achievement for IBM, considering only 2.5% of the largest 1,000 companies are typically able to pass both tests in a given year. The numbers from Value Line Investment Survey are shown in the table below:

IBM Return on Equity and Return on Invested Capital 2004-2013

Metric:

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

ROIC

19.9%

18.3%

23.1%

21.3%

35.6%

31.2%

33.8%

37.6%

39.5%

30.4%

ROE

29.1%

25.7%

33.0%

36.6%

91.6%

59.0%

64.0%

78.4%

88.0%

72.3%

Click to enlarge

Table Source: Value Line Investment Survey

Buffett Metric #2: Price

"The aversion to equities that Charlie and I exhibit today is far from congenital. We love owning common stocks - if they can be purchased at attractive prices. In my 61 years of investing, 50 or so years have offered that kind of opportunity. There will be years like that again. Unless, however, we can see a very high probability of at least 10% pre-tax returns (which translate to 6.5-7% after corporate tax), we will sit on the sidelines. With short-term money returning less than 1% after-tax, sitting it out is no fun. But occasionally successful investing requires inactivity."

--Warren Buffett; 2002 Berkshire Hathaway letter to shareholders

Over the years Buffett has consistently mentioned his desire to purchase companies at a price of 9-10x pre-tax earnings. The one specific example I can remember is the May 5, 2012 Berkshire Hathaway annual meeting that I attended in Omaha. I have the remarks handwritten in my notes from that meeting, and also double checked with the notes of other Berkshire annual meeting note-takers just to confirm.

During the 2012 Berkshire annual meeting question #23 dealt (2012 Berkshire Mtg. notes of Peter Boodell and Ben Claremon) with how to value Berkshire's operating (non-insurance) businesses to ultimately arrive at an intrinsic value for Berkshire. During his response to this question Buffett commented that he would love to purchase operating businesses with similar characteristics to Berkshire's existing operating businesses at a purchase price of 9-10x pre-tax earnings. In concluding his response to the question Buffett also commented if he found a target company with these characteristics he might even pay more than 9-10x pre-tax earnings depending on the situation.

Despite Buffett consistently commenting that he prefers valuing a business on what a rational businessperson would pay for the business in a private transaction, some investors still argue that the 9-10x pre-tax multiple is somehow only related to private deals and not publicly listed companies. I don't believe this to be true as Buffett has consistently commented that he approaches acquisitions in both arenas the same, and an examination of Buffett's recent public company stock purchases (Coke, Burlington Northern Santa Fe, etc.) shows that the purchase price of the public companies consistently meets the 10x pre-tax earnings requirement.

One of my favorite value investors, The Brooklyn Investor, has an excellent post ("10x Pretax Earnings! Case studies: KO, BNI, etc.") where he lays out several case studies of Buffett's stock purchases and how they measure in comparison to the 9-10x pre-tax earnings valuation metric. I'll summarize the acquisition multiples from his blog post below (see the Brooklyn Investor Website for calculations). I highly recommend subscribing to his blog and reading the historical posts as well. He has some excellent and accurate insight you won't find anywhere else.

 

Pre-tax earnings

 
 

Multiple

Year

Coca-Cola

10.1x

1988-1989

American Express

6.9x

1994

Wal-Mart

10.3-12.9x

2005

Wells Fargo

9x

2005

USB

9.1x

2006-2007

USB

7.4-9.5x

2013

BNI Initial stake

9.5x

2009

BNI final acquisition

10.3x

2009

Lubrizol

9.3x

2011

IBM

9.7x

2011

Click to enlarge

Table source: Brooklyn Investor Article, "10x Pretax Earnings"

It seems that a significant number of Buffett's stock purchases are all within a very close range of the 9-10x pre-tax earnings number Buffett has mentioned several times. You'll find that some deals are in excess of this hurdle by a larger margin, including Heinz, but as I described above, Buffett has stated he's willing to pay over 10x pretax earnings if a business has the right characteristics. In the case of Heinz Buffett was also willing to pay a premium for the management of 3G Capital as he was familiar with their absolutely incredible management track record. I highly recommend Cristiane Correa's book on 3G capital, Dream Big: How the Trio Behind 3G Capital - Jorge Paulo Lemann, Marcel Telles, and Beto Sicupira - acquired Annheuser Busch, Burger King, and Heinz.

The IBM acquisition in 2011 averaged a purchase price of 9.7x pre-tax earnings as seen above. A valuation of less than 10x pre-tax earnings meets one of Buffett's business acquisition purchase price ceiling of approximately 10x pre-tax earnings. So from a price and valuation perspective, the acquisition makes perfect sense in light of what Buffett has historically paid for companies.

Buffett Metric #3: The $1 Test: Retained Earnings to Market Value

"Within this gigantic auction arena, it is our job to select businesses with economic characteristics allowing each dollar of retained earnings to be translated eventually into at least a dollar of market value."

- Warren Buffett; 1982 Berkshire Hathaway letter to shareholders

Warren Buffett acquired his $11 billion stake in IBM during 2011 at an average price of $170 per share. During the 10 years leading up to Buffett's purchase (2001-2011), IBM's combined net income was roughly $108 billion, of which $20 billion was paid to shareholders as a dividend. This left IBM with approximately $88 billion to reinvest into the business over the ten year period. During that same 10-year period IBM's total market capitalization (stock price) rose by $80 billion. This equates to the business creating approximately 90 cents of market value for each dollar of retained earnings, and does not meet Buffett's "$1 test" by a margin of 10%.

While this acquisition didn't pass the $1 test criteria, IBM certainly came close to passing, and Buffett does bend the thresholds on his criteria from time to time, as discussed above in the case of the Heinz acquisition exceeding Buffett's 10x pre-tax earnings valuation. In the case of IBM, the company managed to create 90 cents of market value for each dollar of retained earnings, an impressive 10-year track record that is very difficult to achieve, especially given IBM's size at the beginning of the period. I think in this case Buffett concluded that 90 cents of market value for each dollar of retained earnings was close enough in the case of IBM.

Buffett Metric #4: Owner Earnings

"Your goal as an investor should simply be to purchase, at a rational price, a part interest in an easily-understandable business whose earnings are virtually certain to be materially higher five, ten, and twenty years from now. Over time you will find only a few companies that meet these standards - so when you see one that qualifies, you should buy a meaningful amount of stock. You must also resist the temptation to stray from your guidelines: If you aren't willing to hold a stock for ten years, don't think about owning it for ten minutes."

-- Warren Buffet; 1986 Berkshire Hathaway Letter to Shareholders

While IBM has experienced several years where revenue has declined significantly (2004-05, 2008-09, 2011-13), over the long-term the company has consistently increased earnings and cash flow at a significant rate as evidenced by the chart from the Value Line Investment Survey below:

IBM: Average Annual Rates Of

Change (5 & 10 Year Periods ending 12/31/13)

Metric:

10 Years

5 Years

17-19

Revenues

6.5%

6.0%

5.5%

Cash Flow

10.5%

11.0%

7.0%

Earnings

13.0%

14.0%

7.5%

Dividends

19.0%

17.0%

7.0%

Book Value

2.5%

2.5%

NMF

**Source: Value Line Investment Survey

     
Click to enlarge

IBM's 2015 road map calls for earnings per share of $20, so it would seem that this company would be a good bet to materially increase owner earnings over the long-term if you have confidence in management's ability to successfully execute the strategies outlined in the 2015 road map.

Buffett Metric #5: Quality Businesses with Consistent Profitability - "The Ultimate Source of Investment Returns"

"Put simply, profitability is the ultimate source of investment returns. Contrary to popular belief, profitability can be forecast and superior profitability persists. Investors systematically undervalue the unexciting stability of Quality stocks. Rather than being beholden to some black box model of low volatility, or held hostage to some arbitrary optimizer, we prefer to focus on real economic risk. We would argue that a fundamental focus on profitability remains the best way to minimize the true risk with which investors should be concerned."

-- Chuck Joyce and Kimball Mayer; GMO White Paper; "Profits for the Long Run: Affirming the Case for Quality"

Although Buffett began his investing career investing in businesses that were often poor quality and selling extremely cheaply, often less than tangible book value; his approach evolved and began to change significantly around the time Berkshire Hathaway acquired See's Candy, a business of exceptional quality that was much more expensive (relative to operating metrics) than Berkshire's past acquisitions. It was at this point that Buffett began searching for high quality businesses with consistent profits that were selling at a fair price.

Many experts were shocked when Buffett bought the seemingly inconsistent and unpredictable IBM in 2011 especially since Buffett had spent the last 30-40 years buying high-quality, very predictable businesses. In the case of IBM it appears there are two distinct possibilities: (1) Buffett is deviating from his investing approach and making an unpredictable tech investment (2) Contrary to popular belief, IBM has a consistent and predictable business.

When researching this article, I came upon the updated 3rd edition of the first book I ever read about Warren Buffett, The Warren Buffett Way by Robert Hagstrom, who is still my all-time favorite author when it comes to Warren Buffett books. The new edition contains what I've found is the best description of IBM's business quality. Hagstrom states that consulting and systems integration contribute 52 percent of IBM's revenue; 32 percent comes from IT outsourcing, and 16 percent from business process outsourcing. He shows that IBM is the number one global provider of consulting and systems integration, roughly 38 percent larger than Accenture, the next closest competitor. In the global IT outsourcing market, IBM is also number one, and roughly 78 percent larger than the next closest competitor - Hewlett Packard. In business process outsourcing, IBM is the seventh largest provider.

Although technology sectors like hardware and semiconductors are very cyclical in nature, Hagstrom illustrates that the IT services sector benefits from relatively stable growth prospects. In fact, IT services like consulting, systems integration, and IT outsourcing are thought to have "moat-like" qualities according to Morningstar Investment Research. Hagstrom details an interview he conducted with Grady Burkett, the associate director of technology at Morningstar, who demonstrated that intangible assets like track record, reputation, and client relationships are the sources of a moat in consulting and systems integration. Burkett also mentioned that in IT outsourcing, switching costs and scale advantages create their own moats, ensuring customers remain loyal for many years after the initial contract. Companies with moats like those mentioned above typically have high profit margins and returns on invested capital for long-time periods depending on the strength of the moat. It appears that IBM does indeed have a consistent, profitable, and predictable business of very high quality.

Research has shown that high quality companies with consistently high profit margins can greatly increase the investment returns of the long-term shareholder of such companies. In addition, a study done by Jeremy Grantham's firm GMO, LLC (quoted above) has shown that profitability is both predictable and consistent, whereas growth in earnings and revenue revert rapidly to the mean and are extremely unpredictable. The study also notes that industries in Oligopoly-like conditions tend to stay that way much longer than traditional economic theory would suggest.

Over the past 10+ years, IBM has focused on expanding their profit margins, and they have succeeded in improving profit margins from 8.5% in 2002 to over 15% currently. As such, it appears that IBM is a very desirable investment in terms of profit margins.

Buffett Metric #6: Management's Track Record

"I have no use whatsoever for projections or forecasts. They create an illusion of apparent precision. The more meticulous they are, the more concerned you should be. We never look at projections, but we care very much about, and look very deeply at, track records. If a company has a lousy track record, but a very bright future, we will miss the opportunity."

-- Warren Buffett (Seeking Wisdom: From Darwin to Munger, 3rd Ed.)

"And incidentally, the company (NYSE:IBM) laid it out extremely well. I don't think there's any company that's -- that I can think of, big company, that's done a better job of laying out where they're going to go and having gone there. They have laid out a road map and I should've paid more attention to it five years ago where they were going to go in five years ending in 2010. Now they've laid out another road map for 2015. They've done an incredible job."

--Warren Buffett discussing his decision to invest in IBM on CNBC, November 14, 2011

IBM's management has done an exceptional job in the past of achieving the long-term goals they set for the company. In the above referenced CNBC interview in 2011 Buffett mentioned the five-year period ending in 2010. Over this period IBM exceeded management's goal (originally stated at the beginning of 2007) by delivering earnings per share of $11.53 per share; significantly higher than the range management had set as a goal for 2010 EPS ($10-$11). Over this same five-year period, IBM's stock price increased from $70.82 to $137.67 and the company paid out dividends of approximately $9.15 per share. That results in a stock price appreciation of 94.39% and dividend yield of 12.92% on the stock price at the beginning of the period ($70.82 on 1/3/06). Over the same period (2006-2010), the S&P 500 (with dividends included) returned approximately 25.9%. The end result to the shareholder of the original five-year roadmap was a return that outpaced the S&P by 81.41%.

IBM's management has also been incredibly transparent, despite what you may have read in BusinessWeek. The author of the recent BusinessWeek cover story on IBM claimed that an increase in the phrase "non-GAAP" over the period 2009-2013 was an indication of management's dishonestly and lack of transparency. He made this claim without comparing the increase to the increases (or lack thereof) in other public company financial statements over the same time period (or if he had, it was included in his article). If someone had researched this, they probably would have realized that the increase in references to "non-GAAP" amounts was the result of SEC disclosure guidance that came out in 2010, and was responsible for the increase. So the company was actually changing the disclosure due to a SEC rule change, not because of any lack of management transparency. They were following the rules to the letter, not breaking them as it appears they're accused of in the article.

IBM's annual reports are some of the most detailed and informative reports I've seen from any public company, and management does an excellent job of setting long-term goals that the average shareholder can measure the company's operating performance against. And the company is correct to focus on the "non-GAAP" earnings number, as it is a more accurate reflection of the economic reality of the business. But don't take my word for it; Warren Buffett had this to say about "non-GAAP" earnings in his 2011 letter to shareholders: "Non-real" amortization expense also looms large at some of our major investees. IBM has made many small acquisitions in recent years and now regularly reports "adjusted operating earnings," a non-GAAP figure that excludes certain purchase-accounting adjustments. Analysts focus on this number, as they should."

Buffett Metric #7: Mr. Market

"Failing conventionally is the route to go; as a group lemmings may have a rotten image; but no individual lemming has ever received bad press."

-- Warren Buffett; 1984 Letter to Berkshire Hathaway (NYSE:BRK.B) shareholders

"Who's more foolish, the fool or the fool who follows him?"

-- Obi Wan Kenobi

Warren Buffett often references the behavior of Mr. Market, a psychotic person who is willing to sell you the pieces of public companies for extremely irrational prices upon occasion. Buffett also emphasizes the importance of "being greedy when others are fearful, and fearful when others are greedy." Taking advantage of irrational investor behavior has been very advantageous to Buffett over the years.

One has to look no further than a recent BusinessWeek cover story entitled "The Trouble with IBM" to gauge market sentiment on IBM. Not only was the article begging questions, missing points, and full of serious gaps and slips in logical thinking; it appeared to contain several statements and ideas that were factually inconsistent, similar to the discussion of "Non-GAAP" items above. I will address some of the highlights of the BusinessWeek argument against IBM in the following paragraphs.

The author spends the vast majority of the article on IBM's cloud business and seemingly concludes that IBM's cloud business is failing based on one lost government contract which he mistakenly quotes as a $600 million contract, when $600 million was the ceiling, not the final agreed upon price (less than $200 million) He neglected to mention any other quantitative data on the cloud business, and didn't seem to notice that IBM consolidated cloud revenue increased 69% year over year from 2012 to 2013, and this was an 80+% increase over 2011. It seems to me that looking at the business as a whole makes a lot more sense than one isolated contract.

IBM Consolidated Cloud Revenue

  2013 2012 $ Chg. % Chg.
Cloud Revenue (in millions $USD) $4,400 $2,600 $1,800 69.23%
Cloud "as a service" run rate $2,000 $1,000 $1,000 100.00%
Click to enlarge

(Table Source: Page 19; 2013 IBM Annual Report and Page 2 of 2012 IBM Annual Report)

The consolidated cloud data is easily found at the beginning of IBM's annual report, and is much more relevant than one single contract.

There were multiple mentions of "eight straight quarters of declining quarterly revenue" under IBM's new CEO, but upon closer examination this statement doesn't seem to hold up either. Notice IBM's quarterly revenues according to the Value Line Investment Survey:

Quarterly Revenues ($ mil.)

Year 3/31 6/30 9/30 12/31 Total
2011 24,607 26,666 26,157 29,486 106,916
2012 24,673 25,783 24,747 29,304 104,507
2013 23,408 24,924 23,720 27,699 99,751
Click to enlarge

I believe what the author was referring to was the fact that for the last eight quarters, IBM's quarterly revenue has been lower than quarterly revenue one year ago during the same quarter (ex. Q2 2013 revenue lower than Q2 2012 revenue, etc.). While it's true that quarterly revenues have been lower than their prior year counterparts for eight quarters in a row, there have not been eight straight quarters of declining quarterly revenue (see table above) when compared to the previous quarter, and the article leads the reader to believe there have been eight straight quarters of revenue declines as compared to previous quarter, which isn't the case.

The article continued to blast IBM, yet offered almost no statistics on the operating performance of the business, other than a general picture of consolidated quarterly revenue declines, and a mention of declining hardware revenue with no context for what was happening in terms of business cyclicality. The author used terms like "mega-trend" and "downward spiral" yet never explained what these terms mean specifically, and what quantitative evidence there was to support the claims. While he did cite a significant decline in hardware revenue year-over-year and labeled it a "downward spiral," he failed to inform the reader that IBM's hardware business is cyclical and at the tail-end of a cycle. He also failed to mention how small hardware and cloud revenue are to the consolidated revenue of the company. Together they make up less than 20% of 2013 consolidated revenue. Information like the cyclicality of the business and size of each segment is absolutely crucial to understanding the business, yet it was inexplicably left out.

When discussing the company's 2015 Roadmap, he labeled the plan "RoadKill" based on a few random disgruntled employee blog posts and seemed to dislike a plan that was increasing earnings when revenue was decreasing simultaneously. In his explanation of what was causing this phenomenon, he left out the single biggest driving factor of increased earnings even in the face of declining revenues: margin expansion. IBM's annual report show that this has been the most significant contributor to increased EPS both recently and over the past 10-years. The article failed to mention this, and instead mentioned things like "layoffs, stock buybacks, tax planning, and business divestiture." One is left to wonder if they either intentionally left out margin expansion because it didn't fit their narrative of "big, bad, evil" IBM, or if it was just negligence.

The BusinessWeek article also mentioned that the analyst community was extremely bearish on IBM, a sure sign of doom for the company. Although in light of academic research, this conclusion is extremely illogical. The author never mentioned why we should listen to analysts, or if following analysts has led to successful investing in the past, he simply assumed that following analysts is the correct thing to do, without considering any evidence. Academic research has actually shown that the opposite approach (buying stocks with low expected analyst growth) is much more profitable.

Several studies have shown that investors can achieve the highest returns by purchasing stocks that have the lowest expected earnings growth according to analysts. A study by LaPorta (1996, cited in Montier's classic "Value Investing") showed that stocks with the highest long-term earnings growth forecasts produce the lowest returns to shareholders. In 2007 this study was updated (Forsyth; also see Montier's "Value Investing") and the results were consistent. Using 3,200 stocks from 1982-2006, those with the highest average forecast growth rates ended up delivering 11.5% per year, whereas the stocks with the lowest average growth forecast returned 14.5% per year.

The BusinessWeek article quotes the opinions of two "expert" investors, Bill Fleckenstein and Fred Hickey. There is no explanation as to why the reader should listen to these two men, or how their stock picks have performed in the past. We're simply told that they short IBM stock; one has a popular blog, and may or may not have a hedge fund. These two IBM bears are quoted and give their opinions on "funky financial statements," and their desire for "tangible asset growth at tech companies," but don't provide much in the way of actual facts, statistics, or numbers. We aren't even told if their IBM short position has been successful historically. The short sellers complaint about the lack of an increase in "tangible assets," at IBM reminded me of a quote from John Stuart, the chairman of Quaker in 1900, "If this business were split up, I would give you the land and bricks and mortar, and I would take the brands and the trademarks, and I would fare better than you."

In addition, the article fails to mention the other side of the argument, where prominent hedge fund investors Warren Buffett, Ray Dalio, Joel Greenblatt, David Dreman, Jeremy Grantham, and a host of other famous investors with verifiable track records are long IBM stock. We aren't provided any information on investors long the stock other than Buffett, and I would take his side in an argument against Bill Fleckenstein and Fred Hickey 100% of the time. So it appears the IBM article was a bit one-sided, to say the least; but don't take my word for it, follow the link above and read through it yourself.

Another gauge we can look at to measure investor and analyst sentiment is a discounted cash flow analysis. I'm not going to attempt to value IBM based on my subjective ideas for growth in the future, many on this site have already done an excellent job developing their own independent DCF calculations. In addition, it's extremely difficult to predict cash flows into the future, and as Third Avenue Management once stated, "DCF is like the Hubble telescope; move it an inch and you'll end up studying a different galaxy." Instead I will simply use the DCF to see what growth rates are embedded in the current share price. At the current $186 share price (as of the time this article was written), IBM would simply have to grow its earnings at 1.5% a year in perpetuity. Based on IBM's current share price, it seems that analyst and investor expectations for growth are extremely low.

It seems Mr. Market has a pretty negative opinion of IBM lately, and investors have a chance to be greedy when most are very fearful of the company. Some prominent hedge fund investors are already taking advantage of this opportunity, as IBM is currently a holding of Warren Buffett, Joel Greenblatt, Jeremy Grantham, David Dreman, Ray Dalio, and several other prominent fund managers (based on SEC filings). I don't know about you, but I'd rather take the side of the argument that Buffett, Grantham and Dalio are on, as opposed to the side with BusinessWeek, Bill Fleckenstein and Fred Hickey.

Conclusion -- Is the Honeymoon Over?

"Now ask yourself how you came to define the problem as you see it. In all likelihood your view was influenced by the popular press....Here is the broader point: whatever problem you are trying to solve, make sure you're not just attacking the noisy part of the problem that captures your attention."

-- Steven D. Levitt; Think Like a Freak

The BusinessWeek cover story concluded that the "honeymoon was over" for Warren Buffett and IBM due to the company's recent performance. Instead of listening to their opinion, and the opinion of the investment media, let's see what Warren Buffett himself has to say about it. When asked about IBM in the fall of 2013 on the Charlie Rose Show Buffett commented, "They will have record per-share earnings this year ... that can be disappointing if you expected more. But it is not a bad record, believe me." In addition, Buffett stated in his 2011 shareholder letter that a long-term IBM shareholder should wish for the stock price to "languish" over the next five years to provide the company to increase value the most significantly through share buybacks. So it appears that for Buffett, the honeymoon with IBM is just beginning.

In this article I've shown that IBM meets Buffett's criteria for return on capital, purchase price (10x earnings), value creation, profitability, and also fits within his model for behavioral investing. And although many experts lament Buffett's lack of technology expertise, perhaps it is time to trust Buffett's opinion on tech companies, because as Eric Breisacher, regional director at software developer RSA, once stated, "He knows about technology, probably more than we do (From a Bloomberg article in October 2002, quoted in "Of Permanent Value Volume 1)." As Warren Buffett said on CNBC when discussing his investment (paraphrasing Thoreau), "it's not what you look at, but what you see."

Disclosure: The author is long IBM, BRK.B, DVA. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.