What Warren Buffett Sees In IBM, Others Are Missing

Berkshire Hathaway BRK.B +% doesn’t usually invest in technology stocks. But it has been investing in IBM IBM +0.74%, doubling down, as the stock dropped in the third quarter.  Apparently, Mr. Buffett sees beyond IBM’s string of declining quarterly revenues to corporate developments other investors missing.

While we cannot speak for Mr. Buffett, we can point to several metrics that make IBM a solid long-term investment.

IBM’s Key Financial Metrics

Forward PE Operating Margin Revenues (ttm) Qrtrly Revenue Growth (yoy) Div&yield
8.86 20.88% $83.80B -13.90% 3.95%

Source: Finance.yahoo.com

First is the nature of IBM’s innovations—radical technologies that create platforms to help other companies solve big problems. The trouble is that it takes a great deal of time and investment to develop these innovations, and more time for others to adopt them. However, once adoption rates take off, they create new sectors that fuel long growth cycles.

For years, IBM has been riding one growth cycle after another fueled by computing, a sector it has pioneered through heavy spending in R&D. And now IBM is building industry platforms to help clients take advantage of cognitive computing. 

Watson Health, for instance brings together industry expertise, analytics assets and cognitive capabilities, the ability to make sense of ever-growing range of data sets both structured and unstructured and the ability to integrate data and analytics services with Watson API’s in a hybrid cloud environment.

That’s why the company has invested $133 billion since 2004 in R&D, CapEx, and acquisitions—IBM has made 12 acquisitions this year alone.

The acquisition of Phytel, Explorys and Merge, for instance, brings in new kinds of healthcare expertise and data streams.  In particular, Merge gives Watson the ability to see billions of medical images, and make sense of them for doctors in making treatment and diagnosis decisions.

Second is strong growth in emerging businesses: Cloud, Analytics, Mobile, Security.Across all these segments, IBM reached $25b in revenue last year, and is growing 30% so far this year.  These business segments have consistently helped IBM improve gross margins, from 40% a decade ago to 50% in the most recent quarter (up 80bp y-t-y).

Third is IBM’s brand, which occupies fifth position in Forbes’ list of the world’s most valuable brands, thanks to its broad patent portfolio.

Fourth, IBM is a big player in The Internet of Things (IOT), a fast growing technology segment.  To tap into this market, IBM has pursued a host of new acquisitions like the Weather Company. Last March, IBM announced the formation of a new business unit dedicated to accelerating its leadership in IOT solutions and to develop new industry-specific cloud data services.

And fifth is a host of strategic partnerships like the Evry and Etihad, with whom IBM cloud services deals.

The Etihad deal is a $700m deal that will enable the airline to shift to a cloud infrastructure as they rethink all manner of enterprise and customer processes, including introducing new cognitive and mobile capabilities.

Then there is a partnership with Apple to transform enterprise mobility through a new class of business apps—bringing IBM’s big data and analytics capabilities to iPhone and iPad. And an agreement with Twitter—to use data collected from tweets worldwide to predict trends in the marketplace and consumer sentiment about products and brands.

Apparently, there is light at the end of the tunnel for IBM. And seasoned investors like Warren Buffett can see it, buying at a time when others are selling.

And getting paid close to 4% while waiting for the train to exit the tunnel.

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