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Has Warren Buffett Blundered on IBM?

Berkshire Hathaway Inc. Annual Shareholders MeetingBerkshire Hathaway Inc. Annual Shareholders Meeting
Warren Buffett and IBM CEO Virginia "Ginni" RomettyPhotograph by Daniel Acker — Bloomberg via Getty Images

Warren Buffett said on Monday in an interview on CNBC that it’s possible he erred when he bought shares of IBM for his insurance and investment conglomerate. But he doesn’t think so.

Buffett has taken a lot of heat from fellow investors and commentators over his big bet on Big Blue. Nonetheless, Buffett added to Berkshire’s position in IBM (IBM) last year, and said on Monday that he hasn’t sold a share of the stock. In Berkshire’s annual report, which was released on Saturday, Berkshire states in its regulatory filing that it has no plans of disposing of the stock. “We expect that the fair value of our investment in IBM common stock will recover and ultimately exceed our cost,” the report said.

Buffett said on Monday that what he pays for a stock “doesn’t matter.” The market goes up and down in the short-term. But Buffett says the intrinsic value of IBM’s shares is much higher than where the stock is trading now. What matters, Buffett said, is what the stock will be trading for 10 years from now. So, by that math, you won’t be able to evaluate Buffett’s IBM investment until the Oracle turns 95.

But while Buffett wants observers, and most likely his investors, to reserve judgement, there is a way to evaluate the investment aside from merely looking at the current stock price. And, even better, that alternative takes a page from Buffett’s own play book.

Buffett has paid just over $13 billion for his stake in IBM, which accounts for just over 8% of the tech giant. Buffett says he thinks of stock market investments as if he were an owner of the company. Therefore, Buffett considers himself (or, more accurately, Berkshire shareholders) entitled to 8% of IBM’s earnings, even though he can’t actually ask for the money. IBM earned $13.2 billion last year. Berkshire’s share of that would be roughly $1.1 billion. That would constitute an 8% return on Buffett’s overall investment. Not bad, considering where interest rates are these days and the valuations of the stock market.

The picture looks even better if you examine Berkshire’s IBM investment over time. Back in 2011, the first full year Buffett and Berkshire were IBM shareholders, the company had a profit of $15.9 billion. At the time, Buffett had invested nearly $10.9 billion in IBM, giving Berkshire a 5.5% stake in the company, which would translate to $875 million in earnings, giving Berkshire a return of 8%. In 2012, Berkshire purchased another $830 million worth of IBM shares, giving it 0.5% more ownership of the company. That year, IBM earned $16.6 billion. So, according to Buffett’s logic, that would entitle Berkshire to an additional $83 million in earnings. Based on this line of thinking, Berkshire’s investment in IBM had a return of 10% that year. Berkshire’s ownership returns for IBM have gone up from there. Last year, Buffett increased Berkshire’s stake in IBM by $634 million, and its share of IBM’s earnings rose by $79 million, yielding a return of 12%.

Of course, none of this matters if IBM’s shares keep falling. Buffett’s actual investment in IBM has fallen in value by $2.6 billion since 2011. His original stake in IBM generated $725 million in earnings, down from $830 million five years ago. And the tech company is plagued by fears that its huge investment in the cloud and artificial intelligence won’t replace the revenue it is losing in its huge computer services business.

So Buffett’s IBM investment might not work out in the end. But as long as Buffett appears to be buying more and more of IBM’s earnings for less and less, it’s hard to call the investment a blunder.