Did Buffett Buy IBM Because Of The Economy?

Mar.16.12 | About: International Business (IBM)

When it was revealed on November 14, 2011, that legendary investor Warren Buffett had amassed a 5.4% stake in IBM (NYSE:IBM), such news caught many analysts by surprise. After all, the prevailing perception has been that Mr. Buffett is a value investor who has traditionally avoided technology companies and has concentrated his holdings in industrial companies, consumer goods companies, as well as financial services and insurance companies.

IBM is not Mr. Buffett's only technology holding, as 0.42% of his $66.15 billion Berkshire Hathaway holdings as of 12/31/2011 consisted of 11.5 million shares of Intel Corporation (NASDAQ:INTC), equivalent to about 0.23% of Intel's outstanding shares. However, Mr. Buffett's investment in IBM, which he started accumulating as early as March 2011, was a substantial acquisition of 63.91 million shares, comprising 5.4% of IBM's outstanding shares and making up a total of about 17.76% of Berkshire Hathaway's holdings.

IBM Stock Price Chart 1979 - 2012:

Source: Yahoo Finance.

With IBM shares closing at $206 on 3/16/2012, a simple calculation reveals that Mr. Buffett's $10.7 billion investment in IBM has grown by 23% to $13.17 billion. So far Mr. Buffett's investment has paid off handsomely. As he is known to aim to maintain his holdings for the long term, sometimes even "perpetually," what has prompted him to invest a large stake of his holdings in a sector that has been traditionally known to be cyclical and volatile?

In the case of IBM, with its brand name having become such a fixture in the global corporate world, Mr. Buffett must believe that whether in good or bad economic times, IBM will ultimately always come on top. As a matter of a fact, as a value investor, Mr. Buffett is known to only want to invest in companies that will indeed perform well in the long run despite interim economic ups and downs. A recent article by Mr. Ted Berg, "big transformation + big data = big returns," Mr. Berg demonstrates how IBM has consistently transformed itself over time, and has demonstrated the required flexibility in order to flourish.

Has the economy shown Mr. Buffett that in the case of IBM, it will always do well in the long run? Did Mr. Buffett buy IBM because he believes that when the economy does well, IBM will do extremely well, and when the economy slows down, IBM's downside will be limited and short term only? These are questions that Mr. Buffett is very likely to have asked his technology guru, good friend and Berkshire board member, Mr. Bill Gates.

In order to answer such question, we analyzed the performance of IBM, Microsoft (NASDAQ:MSFT), Apple Inc. (NASDAQ:AAPL) and Intel during recent past economic cycles. Our objective is to determine if indeed IBM, as well as possibly other veteran technology companies, can actually weather bad economic times. To do so, we examined how shares in such companies performed during the past five economic contractions, as officially recognized by the National Bureau of Economic Research.

U.S. Economic Contractions since 1980
Contraction Cycle
Start Date
Contraction Cycle
End Date
Contraction Cycle
Duration in Months
A January 1980 July 1980 6
B July 1981 November 1982 16
C July 1990 March 1991 8
D March 2001 November 2001 8
E December 2007 June 2009 18
Click to enlarge
Source: National Bureau of Economic Research

IBM Stock Performance during Contraction Cycles

Cycle Price 1 month before cycle starts Price 1 month after cycle ends Percent change Lowest price reached during cycle Date when
lowest Price reached
% drop for lowest price
A $65.25 65.50 +0.4% $50.38 4/17/80 -22.8%
B $60.25 96.25 +59.8% $48.38 10/29/81 -19.7%
C $119.50 $103 -13.8% $96.50 8/23/90 -19.3%
D $111.20 $120.96 +8.8% $87.49 9/27/01 -21.3%
E $113.65 $117.93 +3.8% $69.50 11/21/08 -38.9%
Click to enlarge
Data Source: Yahoo Finance.

It is evident for IBM that during the past five economic contractions, IBM share price had actually increased in all but the 1990 contraction, from the month before the contraction had started, to one month following the end of such contraction. Meanwhile, the most IBM had dropped during any given contraction was about 19% to 22%, with the exception of the 2007-2009 contraction where at one point it had dropped as much as 38.9%.

From a risk reward perspective, it does seem that holding IBM for the long term had actually paid off, despite temporary economic contractions. In additions, it should be noted that we did not take into account the payment of dividends during such contractions, whereby such dividends provided additional returns to investors.

We also examined the effect of the last three contractions on Intel, Apple and Microsoft.

Intel Stock Performance during Contraction Cycles:

Cycle Price 1 month before cycle starts Price 1 month after cycle ends Percent change Lowest price reached during cycle Date when
lowest Price reached
% drop for lowest price
C $47.50 $49.25 +3.7% $18 10/11/1990 -62.1%
D $37.81 $31.34 -17.1% $18.96 9/21/2001 -49.9%
E $26.50 $19.25 -27.4% $12.06 11/21/2008 -54.5%
Click to enlarge
Data Source: Yahoo Finance.

Apple Stock Performance during Contraction Cycles:

Cycle Price 1 month before cycle starts Price 1 month after cycle ends Percent change Lowest price reached during cycle Date when
lowest Price reached
% drop for lowest price
C $40.75 $55.00 +35.0% $24.25 10/16/1990 -40.5%
D $21.12 $21.90 +3.7% $14.68 9/21/2001 -30.5%
E $187.44 $163.39 -12.8% $78.20 11/20/2009 -58.3%
Click to enlarge
Data Source: Yahoo Finance.

Microsoft Stock Performance during Contraction Cycles:

Cycle Price 1 month before cycle starts Price 1 month after cycle ends Percent change Lowest price reached during cycle Date when
lowest Price reached
% drop for lowest price
C $75.12 $99 +31.8% $50.75 08/25/1990 -32.4%
D $62.38 $66.25 +6.2% $47.50 09/21/2001 -23.9%
E $37.06 $23.52 -36.5% $14.87 03/06/2009 -59.9%
Click to enlarge
Data Source: Yahoo Finance.

It is interesting to note that in the case of Intel, it has been extremely sensitive to economic cycles, exhibiting the most volatility within the contraction cycles in terms of trough price level, and failing to recover as fast as IBM following the end of a contraction cycle. Despite such a finding, Mr. Buffett actually does hold Intel in Berkshire Hathaway's portfolio.

In the case of Microsoft and Apple, despite price volatility within the contraction cycle, they both seem to recover well by the end of the cycle, with the exception of the latest contraction cycle of 2007-2009, although Apple's performance in such cycle exceeded Microsoft's performance.

In conclusion, it is very possible that Mr. Buffett did indeed buy IBM because of the economy. IBM seems to be well positioned to take advantage of a recovering U.S. economy, as well as emerging global economies, while during economic contractions, it seems to be able to recover by the end of such contractions, with a limited downside risk.

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