IBM (NYSE:IBM) is Buffett's third largest holding, and this article is intended to look deeper into the numbers through the eye of the OSV stock valuation and analysis spreadsheets to see why Buffett likes IBM so much.
I'll be focusing on three main parts.
- Business Risk
- Financial Risk
- Earnings Predictability
Before getting started, you can download this full 11-page stock valuation report of IBM.
Buffett invests in businesses with as little risk as possible. While he may understand every detail of the business, Buffett is a mastermind when it comes to identifying strong businesses.
In order to determine how strong a business is, I look at four simple factors.
- Intangibles as a % of book value
ROE and ROA are self explanatory, but if you are unfamiliar with CROIC, it stands for Cash Return on Invested Capital, and is similar to ROE, except it measures how much cash is generated for every dollar of capital that is invested.
e.g., a CROIC of 20% shows a return of 20c for every $1 invested.
But see how IBM stacks up:
IBM scores a 16 out of 20 for its business, but loses 4 points because of the continual increase in intangibles.
16/20 still places it in my excellent range.
Buffett and Ben Graham have always preached to keep things simple. To try and follow this mantra, I have measured financial risk via four simple methods by focusing on the level of debt and how easily it can be paid:
- Current Ratio
- Total Debt/Equity ratio
- Short Term Debt/Equity ratio
- FCF/Total Debt
By focusing on the debt levels and the ability to pay them off with FCF, you get a good indication of the business' health.
If only the debt to equity ratio was better, IBM would have scored high marks, but with a current ratio consistently around the 1.2 mark, IBM is still a safe bet.
Although the debt load has been increasing, IBM can also easily pay off debt with FCF.
With a score of 14 out of 20, IBM is in the above average range.
Buffett loves predictable companies. It helps him sleep at night because by buying great companies, you don't have to toss and turn at night worrying about how the company will fare the next day.
This is where earnings predictability is a great indicator.
The point is to find a company that is consistent across the board, and not just in earnings or earnings growth.
Four factors are analyzed to determine predictability:
- Gross margins
- Net margins
- Cash from operations
In any market, a market leader and consistent company will see little margin fluctuations.
IBM has a solid gross and net margins with slow, but consistent growth.
Earnings are also easier to predict, and if you look at the EPS over the past five years, there is a good steady incline. TTM figures also suggest another slow and steady climb.
Cash from operations is included to break the focus on earnings. Increasing or consistent levels of cash earned by the business is always a good check, and from what we see, IBM has been doing a great job.
18 out of 20: Superb.
By keeping it simple, the numbers already show how IBM is a solid company, and has all the characteristics that Buffett looks for in a company.