Warren Buffett is probably the most intelligent investor on Earth, but even he's not right every time. One of Buffett's most famous picks, International Business Machines Corp. (NYSE:IBM), stopped growing its revenue a long time ago. Third-quarter results were very disappointing, as Big Blue's total revenue declined 4% year to year, sales to growth markets fell 9%, with BRIC market sales falling 15%, and the hardware business unit shrinking 17%.
Aware of poor results, tech investors are shifting resources from IBM to other traditional giants, like software king Oracle Corporation (NYSE:ORCL) -- up 3% in the last month -- or to promising cloud companies, such as Workday Inc (NYSE:WDAY) , up 17% in the last month. As a result, IBM's stock is underperforming, with shares priced around $173. This is just $3 above the price Buffett paid for most of his 64 million shares at the end of 2011. In the long term, is Buffett right about IBM? Can Big Blue fix its business and restart top-line organic growth?
Forget about poor growth, Buffett is right about IBM IBM's revenue and share performance may be disappointing, but the company could still be a good income investment.
First, IBM's management has authorized a five-year, $50 billion share-repurchase program, which is set to significantly reduce the amount of shares outstanding, currently 1.1 billion. This means that the percentage of ownership that each IBM investor holds is set to rise. In the case of Buffett, if IBM's share price remains constant, his ownership could increase from 6.2% to 7.8%, representing millions of dollars.
Second, IBM has been raising its dividend consistently for the past decade. Assuming IBM pays $3.70 per share this year, the company will have raised its dividend 20% annually for the past 10 years, up from $0.70 in 2004. This high dividend is very attractive to long-term investors.
IBM and the race for top-line growth Share repurchases and high dividends make IBM a great stock for a patient value investor. However, revenue growth is also an important investment factor, since nobody wants to invest in a company with a poor business.
As Arne Alsin mentions, two-thirds of IBM's revenue is recurring, that is, derived from locked-in contracts. This is IBM's core business, and unfortunately, is shrinking quickly as companies and institutions move from private clouds and personalized software to cheap, public cloud solutions.
Workday is a company that has taken advantage of the recent technological shift. Unlike IBM, Workday does not offer private cloud infrastructure or personalized IT systems. Workday is a cloud company offering software as a service for human capital management, data analytics and accounting. Most of its customers are medium-sized businesses, but it has also closed important deals with Fortune 500 companies. Workday represents the new type of competitor that traditional tech giants have to face. In the past two years, while IBM's revenue contracted 5% and Oracle barely grew its top line, Workday experienced an amazing 84% revenue increase.
The good news is that, despite its recent revenue contraction, IBM's long-term prospects remain attractive.