IBM’s (IBM) 8.3% face plant on April 19th following a disappointing quarterly earnings report likely didn’t set off any quaking in Omaha. Berkshire Hathaway (BRK-B) chairman Warren Buffett just might be a little pleased that IBM retreated.
After spending $10.9 billion in 2011 to scoop up 5.5% of IBM’s outstanding shares -- making Berkshire its largest shareholder -- Buffett wrote in that year’s shareholder letter: “We should wish for IBM’s stock price to languish throughout the [next] five years.”
Buffett’s reasoning boiled down to wanting to get the most bang for the buck as IBM management continued on its long-term path of stock buybacks.
In the letter Buffett set up an educated hypothetical that IBM might spend $50 billion repurchasing shares over the five years. This excerpt from the 2011 shareholder letter explains why Buffett was likely a cool customer during last week’s steep sell off:
“Let’s do the math. If IBM’s stock price averages, say, $200 during the period, the company will acquire 250 million shares for its $50 billion. There would consequently be 910 million shares outstanding, and we would own about 7% of the company. If the stock conversely sells for an average of $300 during the five-year period, IBM will acquire only 167 million shares. That would leave about 990 million shares outstanding after five years, of which we would own 6.5%.
“The logic is simple: If you are going to be a net buyer of stocks in the future, either directly with your own money or indirectly (through your ownership of a company that is repurchasing shares), you are hurt when stocks rise. You benefit when stocks swoon.”
IBM has been an aggressive share repurchaser for a very long time, reducing shares outstanding by nearly one-third over the past decade.
The income seekers chasing after dividend paying stocks don’t feel much love for IBM. The 1.74% dividend yield is below the yield of a 10-year Treasury and well off the 2% average yield for the S&P 500. But that’s just being yield wise and payout foolish. For starters, IBM’s dividend payout has grown 70% over the past five years. Not too shabby. And when you combine the dividend yield with the value of the share reduction that came from buybacks -- what’s known as net payout yield at Ycharts -- you see the value of what Buffett is talking about.
That’s not to say that buybacks trump all. “In the end, the success of our IBM investment will be determined primarily by its future earnings” Buffett wrote in the letter. Earnings are the fuel that funds the business and allows for management to keep up the share repurchase and dividend growth.
And last week, IBM’s first earnings miss since 2005 sent the stock tumbling. But IBM management insisted the problem was poor execution in closing sales, not that business was abjectly turning south. IBM says it expects per-share earnings for this fiscal year to come in at $16.70. That would be 16% higher than last year’s earnings. Not exactly an implosion.
Moreover, if IBM comes to the conclusion its product and service lineup is lacking (there is much consternation on the street that it is losing ground as corporations opt to rent data management in the cloud) there’s ample money in the till to bankroll a deal or two.
Despite last Friday’s dramatic 8% drop, Buffett still hasn’t exactly gotten his languish wish. Berkshire spent about $170 a share on its initial $10.9 billion purchase in 2011. IBM closed at $190 last Friday. That gives Berkshire shareholders a 12% price gain on the original $10.9 billion investment. The S&P 500 rose 14.2% over the same stretch.
Since establishing the position in early 2011, Buffett has bought more IBM shares in every subsequent quarter. While the Street bailed last week, it wont’ exactly be a surprise if we eventually learn Buffett used the opportunity to get greedy among the fear and buy some more IBM shares.
Carla Fried, a senior contributing editor at ycharts.com, has covered investing for more than 25 years. Her work appears in The New York Times, Bloomberg.com and Money Magazine. She can be reached at firstname.lastname@example.org.
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