IBM Undervalued At Its Current PriceBRK.A),(BRK.B) is the largest shareholder in IBM owning more than 20 million than the second largest holders. Warren Buffett added to his position during the first quarter and now he is sitting on a quotation loss of $700 million.
Warren Buffett did an interview with CNBC back in May where he discussed why he bought more IBM shares. He believed that in ten years from now IBM will be earning more than they are now and will have fewer shares outstanding. Warren believes Berkshire will make a conservable amount of money on its investment in IBM over the next ten years. I agree with Mr. Buffett that IBM is a great value play that is offering investors pretax return of 16% that is double the current yield on a 10 year US Treasury bond.
The IBM's share price falling is a blessing for long-term savvy investors who can now add to their positions or acquire a position in IBM at a 31% from estimated business value. IBM is now selling for around 10x its next year earnings and around 13x last year's earnings. Since 2010, IBM has reduced its share count around 20 percent. This has increased its earnings per share. The company during this same period has been reporting declining revenues, and sales have been flat since the first quarter of 2012. Thanks to financial engineering IBM has been able to increase its earnings per share while sales and revenues have fallen or been flat. So Warren is correct, the company in 10 years will be earning more and will have fewer shares outstanding.
At its current price IBM is a buy offering a potential pretax return of 16% and selling for around 8.5x pretax earnings. If IBM sold for 10x its pretax earnings then the company would sell for $197.50 per share. The company has a Greenblatt earning yield of 10%, a forward rate of return of 12% and a pretax return of 16%. When you compare IBM's earning yield, forward rate of return and pretax return to the ten year treasury, you are to get twice the return on IBM then you will get investing in 10 year treasuries. Over the last ten years the company return on equity has averaged 58%, and its return on invested capital has averaged 29%. Over the next ten years IBM will continue to reduce its share count through buyback which will lead to increasing earnings per share. Earnings per share for IBM over the last ten years grew at around 14%. I believe the company's earnings per share will grow at around 14% over the next 10 years due to the company reducing its share count by 20% and will have a buyback program in place.
By using discount cash flow you can get the value of the company by using a 12, 15, and 17% discount rate to give use a range of estimated business value for IBM. At these discount rates the company is offering a range of margins of safety from 47% to 22%.
- At a 12% discount rate the fair value for IBM would be $308.07/share.
- At a 15% discount rate the fair value for IBM would be $247.23/share.
- At a 17% discount rate the fair value for IBM would be $207.85/share.
By Cody Eustice