Follow Buffett's footstep for a great value stock

As I said, IBM is a great value company. At the current price around $185, it is deeply discounted and cheap, a valuation you don't often see. You should buy and hold IBM forever. By the way, the trade I talked about a few days ago has already shown me good money (up 30%). By the way, I used some variation for the trade by using $185 as the strike price with a bit more "risk" but to me it is no-brainer or free money anyway. Also, this is just my short-term income trade to juice up my long-term position of IBM.

 
Now, what Buffett thought about IBM? Well, Buffett considered IBM as one of Berkshire’s “Big Four” investments – American Express, Coca-Cola, IBM and Wells Fargo. He bought 63.9 million shares of IBM worth $10.9 billion in 2011. Since he liked it so much at the price and valuation, he purchased additional shares of IBM in 2012 and increased their position from 5.5% to 6.0%.

I guess you all would agree with me that Buffett is by far the most intelligent investor in the world. His wisdom is insurmountably valuable. When he talks, I listen, so should you. Instead of that I'm trying to convince you  about how valuable IBM is, let's see how Buffett talked about IBM in his 2011 annual letter. For such a great value stock, Buffett advised that one should wish for lower (languish) stock prices rather than higher prices, if he or she wants to keep it for long term.  See below (red highlighs mine) and you can read Buffett's full 2011 shareholder letter here.

 Let’s use IBM as an example. As all business observers know, CEOs Lou Gerstner and Sam Palmisano did a superb job in moving IBM from near-bankruptcy twenty years ago to its prominence today. Their operational accomplishments were truly extraordinary.

But their financial management was equally brilliant, particularly in recent years as the company’s financial flexibility improved. Indeed, I can think of no major company that has had better financial management, a skill that has materially increased the gains enjoyed by IBM shareholders. The company has used debt wisely, made value-adding acquisitions almost exclusively for cash and aggressively repurchased its own stock.

Today, IBM has 1.16 billion shares outstanding, of which we own about 63.9 million or 5.5%. Naturally, what happens to the company’s earnings over the next five years is of enormous importance to us. Beyond that, the company will likely spend $50 billion or so in those years to repurchase shares. Our quiz for the day: What should a long-term shareholder, such as Berkshire, cheer for during that period? I won’t keep you in suspense. We should wish for IBM’s stock price languish throughout the five years.

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%. If IBM were to earn, say, $20 billion in the fifth year, our share of those earnings would be a full $100 million greater under the “disappointing” scenario of a lower stock price than they would have been at the higher price. At some later point our shares would be worth perhaps $1 1/2 billion more than if the “high-price” repurchase scenario had taken place.

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.

Emotions, however, too often complicate the matter: Most people, including those who will be net buyers in the future, take comfort in seeing stock prices advance. These shareholders resemble a commuter who rejoices after the price of gas increases, simply because his tank contains a day’s supply.