Today I would like to share a story of all time investment legend – Warren Buffett’s IBM investment story.
Mr. Buffett confesses not understanding the technology. Hence he stayed away from investments in the technology business as it is hard to know the long-term enduring advantage.
International Business Machine (IBM) Inc. is an over-century-old technology company. It was the front-runner for many technological firsts and innovations. However, since the 1990s, companies have been struggling and downsizing operations often.
Buffett had been studying IBM for over 50 years before he first purchased it in 2011. He acquired a total of 5.5% outstanding shares for $10.9 billion. This took IBM investment to the top four of Berkshire along with American Express, Coca-Cola, and Wells Fargo.
Buffett bet on four things: 1) IBM’s share buybacks, 2) dividends, 3) management, and 4) customer “stickiness” from large deals.
He was fascinated by IBM's investments. He used almost one page of Berkshire’s 2011 annual report to explain IBM’s repurchase policy. He was very bullish on repurchases. He speculated that IBM could buy back all the shares someday. That would leave only Berkshire’s holding of 63.9 million shares (from 5.5% to 100% holding!). He also committed to giving Berkshire employees one day of paid leave, if it happens.
Buffett was confident about IBM's business outlook, but he acknowledged that it was not as “bullet-proof” as Coca-Cola. He kept on purchasing IBM shares till 2015 to take his holding to 8.4%, for a total investment of $13.8 billion.
However, since 2014, IBM's stock price has been dropping. It has been accused of financial engineering its accounts. Berkshire’s holding value dropped by 19% to $11.1 billion. During Berkshire Hathaway Inc. AGM, a shareholder questioned the logic of holding IBM. In response, both Buffett and Munger endorsed IBM as having been purchased at a reasonable price.
There were fundamental business issues with IBM; it was falling behind other technology competitors in products like Cloud-based and in-service contracts. Later in 2017, Buffett admitted his mistake. He was still thinking of IBM as a big, strong company. However, he acknowledged that IBM has bigger and stronger competitors.
He was able to sell a reasonable quantity of shares above $180 per share versus the original cost of $170. Finally, by the end of 2018, he sold his complete stake in IBM.
Buffett's IBM purchase was one of the biggest mistakes. He had crossed his ‘Circle of Competence’.
The mistake was further compounded by holding onto the loser even though it was clear that the company was struggling. The advances in technology and fast pace of competitors, like Amazon Cloud (AWS), disrupted the market.
Later in 2017 Berkshire AGM Munger confessed the mistake and informed the shareholders “Well, we avoided the tech stocks because we felt we had no advantage there and other people did. And I think that’s a good idea not to play where the other people are better.”
Hence the biggest lesson for the investors is to have the discipline to understand their own circle of competence and stay within it. She or he must understand its boundaries and honor.
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