Introduction
*Held personally and/or by the
private fund I manage
Many of today’s
portfolio managers and most individual investors don’t know during my
investment lifetime there was one very prominent growth stock that was the
Apple of its day, International Business Machines or IBM. In last week’s blog
post I suggested that critical investment and business management courses could
be focused on Berkshire Hathaway; I believe every investor who is going to
devote a significant portion of his/her portfolio should also have a
course on IBM. (This thought was triggered by a lengthy article in a Sunday New
York newspaper on the company’s attempting to a bring a style focus to its
products. As usual with this paper it was an incomplete piece which neglected
to track the major shifts in how IBM’s shareholders have viewed its stock over
time. The change of their attitudes mirrored many of the changes in the
operations of the company.)
A Personal Note
My Grandfather who led
his own brokerage firm for the first twenty or so years of the 20th
century told his grandchildren about being one of the few outsiders other than
company executives to attend a dinner with the then CEO Tom Watson and many of
his family who were placed at each table. My Grandfather was not a security
analyst, (at that time called statistical people), or a technologist of any
type. He was impressed with the reported growth of the company and was
impressed with Mr. Watson. On the basis of this appreciation and friendship IBM
played a prominent role in many investment accounts for my family. When my
brother and I became professional investors, we urged with some trepidation that
the oversized positions be reduced as the market had placed a higher value on
IBM’s growth than we did. At the present
time I don’t directly own any IBM and it is not a prominent position in our
much larger investments in mutual funds. Perhaps, as the company evolves to
more of a service company we should own the stock, but I hope more of our
growth oriented mutual funds take positions in IBM.
I have had three other
interactions with IBM that colored my evolving views on the company. The first
was that while in the US Marines (as often the case in training as one of the
smallest Marines) I was assigned to carry and fire a Browning Automatic Rifle
(BAR). It was the only automatic weapon the infantry squads carried. It was
considerably heavier than our usual rifles particularly with its ammunition.
During World War II IBM converted its factories to war production including
BARs.
The second interaction
was when I was setting up my performance analysis service, I wanted to have our
own in-house computer rather than continuing to rent time on a trucking
company’s mainframe. Not surprising my
computer associates talked me into going on the waiting list for the IBM 360
computer. Perhaps as part of the sales effort I was invited to spend close to a
week at a school for IBM clients which was very interesting in terms of theory
and a tour of its manufacturing line. (I must admit that the most long-term
benefit of the school was for me to get to know the soon to be president of a
client who was executing a major turnaround of a slowing great old name in the
mutual fund business. He succeeded.) After returning from the school I was as
usual impatient to move ahead and not wait six months for delivery. So I
cancelled the order and had a Wang (which was good for us) operating within a
few weeks.
The third interaction
was that IBM was using our mutual fund data within their domestic pension
operation. The domestic side did not control the retirement activities for the
foreign affiliates. The domestic people asked whether we could help with providing
statistical guidance for the separate foreign plans. At that time we had too
little that we could do to help them, but the request reinforced the need for non-US fund data in my mind. This in turn
led to opening of offices in London and Hong Kong and the eventual sale of the
data operations to Reuters Group. All of these interactions demonstrate to me
that IBM is a multifaceted jewel that has been evolving for 104 years and like
the blind men feeling the elephant, each interaction is informative, but
incomplete.
A Brief Financial
History
The original people of
IBM came out of National Cash Register and formed a punch card reader and
related products producer. The company that they formed had more debt than
equity when it was publicly traded. Thus IBM started its financial history as
what was then called a “watered” stock. We would call it junk. (The term ‘watered
stock’ came from the stock yards where cattle were bulked up through large
consumptions of water.) One of the functions of the punch card reader that was
the company’s initial main product was reading punch cards of employee hours.
Thus at one point it is possible that IBM was the largest clock producer in the
US. During the Depression era the financial conditions were so stretched that
the company paid its clock repair people partly in company stock. Years later
some of these workers had multi million dollar portfolios for repairing time
clocks. During WW II as much as possible the company’s manufacturing base was
converted to war work. During the war some of IBM’s research was on the
beginnings of the computer. Initially Tom Watson was not a believer in its
commercial development. He is quoted in 1943 as saying, “I think there is a
world market for maybe five computers.”
As shown in last week’s
post on Berkshire Hathaway, analysts need to pay attention to legal, accounting
and tax elements. IBM conducted its foreign activities in IBM World Trade which
for a number of years was not consolidated fully into the company’s financial
reports. Many of us analysts performed this task, including calculating the
overall tax rate. One of the mistakes many early analysts made is that they
thought of IBM as a manufacturer. In truth most of its revenues after the War until
relatively recently were from leasing computers directly to ultimate users or
third-party leases. Due to length of the leases one could project with a high
level of certainty what future revenues would be. The leasing activities were
helped greatly soon after the War ended. Prudential loaned IBM at that time a very large
$100 million for at least one hundred years. Thus IBM which was in effect a
finance company, but was viewed as a leading institutional growth stock with a
high multiple.
By the time I came to
Wall Street in 1960, IBM was probably the single largest holding in most trust-quality
portfolios. (Hence my family’s over commitment to the stock.) The company had
competitors including Sperry Rand which had major support from General MacArthur
for use in re-building Japan. None of the other competitors had IBM’s installed
base of leasing revenues so they competed on both price and technology. Often
the competition came down to IBM’s image, financing, and a good sales force
against lower prices and faster machines. In addition, IBM’s sales force
included sales engineers, think of Ross Perot. In response to the competitive
pressure, the firm bet its future on a new computer system the 370 which
eventually succeeded, but with lots of additional expense which hurt the
relative stock price. Over time the fall in the stock price was halted by the
dividend yield.
Thus over its history
the IBM stock was viewed as an extremely leveraged speculation, an essential
business manufacturer, a high quality growth stock, an income stock, and a
turnaround candidate.
What Makes a Growth
Stock
In essence a growth
stock is a stock that many market participants will trade higher into the
future. This is usually expressed as earnings per share growing faster than the
market. I take a different point of view
as follows:
1. All growth is cyclical and for some future
periods each item will under-perform.
2. I am not interested primarily in statistical
measures. I am primarily interested in growth...of my capital.
3. Combining the first two points I want to own
value stocks that become growth stocks and growth stocks that become value
stocks.
4. To accomplish these goals I have two valuation
metrics. The first is the long-term prospect of dividend growth. (The only
reason for buy backs is to benefit management with their short-term employment
contracts and remove some of the takeover target value.) The second metric is
the strategic value of the company to a knowledgeable buyer.
Why is Growth Important Now?
In these posts we have introduced the Timespan L
Portfolios®. We will need to populate at least half of the Endowment
Portfolio with Growth investments, and even more in the Legacy Portfolio. As of
the twelfth of November the only major mutual investment objectives both US and
non-US showing positive performance are growth funds of varying market
capitalizations; Large-Cap Growth +4.9%, International Small/Mid-Cap Growth
4.34%.
Globally the current job imbalance is reinforcing the
focus on the lack of qualified workers to fill existing jobs. This indicates
that there is a growing replacement of labor with capital, in part evidenced by
machines. According to a recent advertisement by Fidelity, 80% of global GDP
comes from non-US countries and only 26% of the world’s publicly traded
companies are based in the US. Further a Bank of England economist suggests
that up to 50% of the existing jobs in the UK could be replaced by smart robots
in the future.
As a global society we need to support growth as a
way to solve our growing employment problems. I wonder if the murderers involved
in the dastardly attacks in Paris would have chosen a different approach to
life and death if they were employed in a growth sector.
_________
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Copyright © 2008 - 2015
A. Michael Lipper, C.F.A.,
All Rights Reserved.
Contact author for limited redistribution permission.
All Rights Reserved.
Contact author for limited redistribution permission.
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