Buffett Buys IBM: A Quality, Improving Stock At A Good Price

Nov.21.11 | About: International Business (IBM)

We saw last week that Warren Buffett bought about $10.7 billion worth of IBM (NYSE:IBM) stock. “I felt that IBM had a very good business,” said Buffett. Many commentators expressed surprise at this development, as Buffett has traditionally chosen to avoid technology stocks, whereas IBM is in many ways a quintessential technology stock; the company provides a wide variety of technology services and products, including enterprise software, cloud computing, business analytics and IT solutions to firms worldwide. The company was founded in 1911, and employs over 400,000 people.

We are always curious to see how stock picks from the Oracle of Omaha measure up in quantitative terms, so we ran IBM through our company search feature, which gives a an overview of subject companies across a number of statistical dimensions.

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Our Turnkey Fundamental Factors for IBM, above, show a Quality Measures score of 76.8%, and a Pricing Measures score of 55.4%, which combine for an overall Turnkey Score of 66.1%. So in general, we see that IBM looks like a high quality company, at a below average price. Let’s take a closer look at these measures, in order to learn some more about what is driving these numbers.

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Our Economic Moat output, above, and overall score of 84% is showing that IBM is a high quality company along traditional quantitative measures of sustainable competitive advantage. IBM generates normalized (8 yr average) cash from operations – CAPEX / assets returns of 94.5%, which places the company in the top 5% of our screening universe. Normalized (8 yr average) returns on assets of 10.5%, and on capital of 16.0% are also strong, in roughly the top 10-15% our universe. Margin strength is solid, with a value of 3.32%, also near the top 15%. Finally, the company has not lost money in any of the past 8 years. Indeed, Buffett was quoted as saying, “There’s a fair amount of presumption in many places that if you’re with IBM, you stay with them,” a sentiment that seems consistent with these statistics. Overall, the company is showing strong, stable cash flows and returns over long time frames, which suggests IBM enjoys some ability to maintain profits and market share, even in the challenging technology space.

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Turning to our Recent Operation Improvements output, above, we see that IBM has been doing many things right over the past year. Revenues and net income are up, as are gross margins. Returns on capital and on assets have also increased versus the prior year. The quick ratio has improved. Asset turnover has increased, as the firm is doing more with fewer assets. The only blemishes are a slight increase in debt/capital, and a negative change in A/R turnover. The overall Improvement score of 77% is a strong indicator that IBM has had success along a number of critical statistical categories.

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IBM’s Financial Health scores also look good. The company has positive net income and cash flow, and generates $12 billion in normalized (8 yr average) earnings. Returns on assets and capital are also strong, and contribute to IBM’s 100% Profitability score. Stability measures also look reasonable. IBM boasts an f-score of 8 out of 9, which is phenomenal. IBM’s Altman Z score of 4.4 suggests there is little reason to worry about financial distress. Moreover, IBM’s coverage ratio of 50X looks safe, and the quick ratio is over 1.0. In general there are no blindingly obvious problems.

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Our shareholder yields for IBM look respectable. Net income to market cap yield of 7.11%, is in the top third of our universe, as is normalized (8 yr. average) net income to market cap yield of 5.12%. IBM looks cheaper than average on TTM EBIT and FCF/TEV basis, with returns of 8.6% and 5.6% respectively, as well as on a normalized (8 yr. average) EBIT and FCF/TEV basis, with returns of 6.11% and 6.45%. IBM does look expensive on a book to market basis, but hey, this is a technology company that is generally not generating cash flows based on an asset. Overall, our Shareholder Yields score of 55.4% is suggesting that IBM is trading at a fairly cheap price.

Taking a step back, despite Buffett’s departure from his traditional disinclination to purchase technology businesses, this investment in IBM has many Buffett hallmarks. The firm is a very high quality business, with strong long term returns and margins, and a stable customer base. IBM has been doing many things right over the past year, growing its business and improving its operations. The firm looks healthy. Finally, the stock does not look overpriced. While there are better statistical bargains out there, you are getting a better than average price for this high quality company. Given that Buffett has to find value in very large capitalization stocks, it appears as though he has a done a good job at selecting a good firm at a good price.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.