Buffett Bought IBM For A Good Reason

| About: International Business (IBM)

IBM is one of the most influential American companies in the world. Despite its massive market cap of $232 billion, the company enjoys a relatively low P/E of 15. In the last decade, the company's stock price increased 101%, up from 98.45% to $197.61.

Meanwhile, the company's revenues jumped by 63%, up to $29.49 billion from $18.03 billion. Its earnings per share in the twelve trailing months improved from $4.05 to $13.12. This is an increase of 224%. the fact that the company's earnings grew nearly 4 times faster than its revenues demonstrates that IBM moved its operations to much higher margin businesses in the last 10 years.

The chart below presents the growth of the company's market value, revenues and earnings in the last decade. The orange line represents the share price appreciations, the blue line represents the revenue increase and the red line represents the earnings increase.

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The chart below presents IBM's profit margin growth in the last decade. 10 years ago, the company had a profit margin of 6.61% whereas today it enjoys a profit margin of 18.62%.

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This also reflected in the company's increased free cash flow in the last 10 years.

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Obviously, IBM's transition in the last decade has been successful. IBM's IT services and software business serve as the main engine of growth for the company. In 2011, IBM's software revenue was up by 9% and IT services revenue was up 13%. The company saw a revenue growth of 13% in US, Canada and Mexico. It saw similar growth trends all over Europe at a year European economy has been slowing. IBM saw double digit percentage revenue growth in 40 countries. The company reported double-digit EPS growth for 9 years in a row.

Among many others, Hewlett Packard (NYSE:HPQ) and Oracle (NASDAQ:ORCL) are main competitors of IBM. Hewlett Packard is going through the same transition IBM did 15 years ago but it might not get as lucky as IBM did. When IBM was going through its transition, there was plenty of market share for IBM to grab, however HP will not have such a "hungry" market in front of itself. Also, HP will have to invest very large amounts of money, talent and time in order to build the infrastructure and expertise similar to the one IBM enjoys today. Oracle became a major player in software/IT business after acquiring Sun Microsystems a few years ago. I believe Oracle has a strong business model and a lot of potential, and I am also favorable about the company, however IBM and Oracle can coexist and grow together. In the last 2 years, IBM claimed near 2,000 competitive displacements from Oracle and HP combined. One strength IBM has over Oracle is that it enjoys better hardware sales in addition to software. For example, in 2011, IBM captured $2.3 billion worth of hardware business from current or former clients of Oracle.

Looking Forward

Emerging markets will play a big role in IBM's growth in the foreseeable future. In 2011, the company added 92 new branches with 1,500 sales staff in its portfolio. These sales representatives not only create new business, they also engage in competitive displacement which amounted in $350 million in 2011.

In the last year IBM bought 5 companies with $2 billion of its cash. The company is also investing money into building IT infrastructures in many countries. The company is committed to keep buying promising companies.

IBM's software brand WebSphere witnessed sales growth of 21% with each software product under this brand name seeing a growth between 10% and 25%. Tivoli, another software by IBM saw sales growth of 14% in the last quarter. I believe IBM's acquisition of Q1 Labs was spot on, and it will help drive growth in the future.

Another great opportunity for IBM is Netezza. The company grew its client base by 40% since acquiring Netezza and every third transaction in the last quarter came from Netezza. This will continue to be one of the major growth sources for the company in the near future.

Most analysts covering IBM rate the company as either "Strong Buy" or "Buy" with an average price target of $250. This indicates an upside of 25% for the stock. I agree with these analysts and see great potential in IBM.

Disclosure: I am long IBM.