I was recently reading the late Phil Fisher’s Common Stocks and Uncommon Profits and was struck by the similar logic employed by both Fisher and Buffett in their praise of IBM (IBM). On page 61 of Fisher’s famous work, he has this to say about IBM:
“… International Business Machines is a company which has (speaking conservatively) handsomely rewarded its owners. An IBM executive recently told me that the average salesman spends a third of his entire time training in company-sponsored schools! To a considerable degree this amazing ratio results from an attempt to keep the sales force abreast of rapidly changing technology. Nevertheless I believe it one more indication of the weight that most successful companies give to steadily improving their sales arm. A one-time profit can be made in the company which because of manufacturing or research skill obtains some worthwhile business without a strong distribution organization. However, such companies can be quite vulnerable. For steady long-term growth a strong sales arm is vital.”
Although the IBM of the 1960s and 1970s is not the same as the IBM of 2011, Warren Buffett expressed a similar rationale for loading up on almost $11 billion worth of IBM’s common stock for Berkshire Hathaway (BRK.A)(BRK.B).
The interview is very long, but one of my favorite was when Buffett told a personal anecdote about the time that he tried to compete with IBM fifty years ago:
“We actually started — I was chairman of the board, believe it or not, of a tech company one time, and computers used to use zillions of tab cards and IBM in 1956 or '7 signed a consent decree and they had to get rid of half the capacity. So two friends of mine, one was a lawyer and one was an insurance agent, read the newspaper and they went into the tab card business and I went in with them. And we did a terrific job and built a nice little company. But every time we went into a place to sell them our tab cards at a lower price and with better delivery than IBM, the purchasing agent would say, nobody's ever gotten fired from buying — by buying from IBM. I mean, we probably heard that about a thousand times. That's not as strong now, but I imagine as you go around the world that there are — there's a fair amount of presumption in many places that if you're with IBM, that you stick with them, and that if you haven't been with anybody, you're developing things, that you certainly give them a fair shot at the business. And I think they've done a terrific job of developing that. And if you read their reports — if you read what they wrote five years ago they were going to do and the next five years, they've done it, you know, and now they tell you what they're going to do in the next five years, and as I say, they have this terrific reverence for the shareholder, which I think is very, very important.”
What I find interesting is that both Buffett and Fisher expressed concern (or at least, skepticism) about owning technology companies because of their very disruptive nature — Buffett had been famous for saying “I don’t buy tech companies because I don’t understand them” but I suspect that what he really means to say is that the competitive advantages and durable moats of tech companies are usually so thin that, as a potential part owner of the business, it is very difficult to guess what the firm’s landscape will look like in ten years. After all, it’s much easier to predict that Coca-Cola (KO) will be selling a large number of Coke and Diet Coke in ten years, and it’s probably reasonable to assume that Proctor & Gamble (PG) will be selling a large supply of Gillette razors in 2020 as well. But it’s not as easy to guess what Apple (AAPL) or Microsoft (MSFT) will look like in ten years.
But of course this raises the question — what is it that Fisher and Buffett have seen in IBM that make them think it is reliable enough to predict earnings over 5-10 year stretches? Well, Fisher liked the devotion that IBM management dedicated to its sales arm, and Buffett likes the ‘stickiness’ of the relationship between IBM and its clients. As Buffett said, “No one ever gets fired for going with IBM.” That’s a powerful statement about the company’s brand that transcends the pure utility of its products and services.
Over the past year, we’ve seen shares of Research and Motion (RIMM) fall from $70 to $17 per share as the Blackberry has demonstrated a tough time competing with smart phones from the likes of Google (GOOG) and Apple (Apple). Buffett and Fisher both detest this type of susceptibility to product shifts — because Buffett believes there is a legitimate long-term tie that prevents IBM’s clients from seeking another firm to meet its tech servicing needs, IBM’s market share and earnings growth are more predictable than that of other tech stalwarts. Keep in mind that if IBM meets the objective of its five year plan and earnings double, the commensurate expected stock price increase to reflect that earnings growth could very well make IBM the largest investment holding of Berkshire Hathaway, which ought to tell you what Buffett thinks of IBM’s durable advantages.