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Buffett Just Spent $12 BILLION on IBM. Should You Follow his Lead?

The opinions expressed by columnists are their own and do not necessarily represent the views of Townhall.com.

Has Warren Buffett drawn up a new playbook? The legendary mega-investor who has created vast wealth for shareholders through his investment vehicle, Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B), has announced that he's been secretly buying shares of one of the world's largest tech stocks: IBM (NYSE: IBM).

The move is curious for a pair of reasons. First, he's notoriously averse to technology stocks, because they typically fail to conform to his tried-and-true value approach. IBM's shares don't seem like a huge bargain at 17 times trailing earnings. In contrast, rivals such as Hewlett-Packard (NYSE: HPQ) appear to possess much more appeal for value investors, as I noted in this article.

Then again, IBM is firing on all cylinders (as usual), while HP is likely on the cusp of a restructuring. Second, he's loading up on Big Blue AFTER the stock has made a remarkable run during the past decade.

[Fans of our own super-investor, Amy Calistri -- the brains behind our Stock of the Month newsletter -- know you could have followed her advice in March 2010 and bought this stock when it was $60 cheaper. She's now sitting on a 50% gain.]

Buffett's heavy amount of buying came under the radar. His current stake, which now tallies roughly $12 billion, didn't appear on any of the quarterly 13-F filings that detail portfolio changes. Berkshire Hathaway received an exemption from the requirement, citing competitive needs for secrecy. If others knew of the firm's massive buying of IBM shares, then they would have mimicked the move and pushed the stock price up quickly.

That 13-F mandate may have been waived, but an ownership stake above 5% is what compelled Buffett to finally acknowledge the buying spree. At that level, Berkshire Hathaway is considered to be a "Beneficial Owner," so every transaction from here on out will have to be registered with the Securities & Exchange Commission (SEC) unless the stake moves back below 5%.

We don't know the actual timing of the purchases, but if history is any guide, a value player such as Buffett likely took advantage of dips and had a nice entry point for IBM earlier this summer.

In several interviews this week, Buffett expressed great admiration for IBM, citing the company's ability to adroitly adjust to the changing tech landscape, putting more resources into areas of information technology (IT) spending that are attracting the strongest funding and offer the strongest margins. At the same time, IBM has no problem deemphasizing weaker parts of the IT landscape, shedding businesses where necessary. As a result, annual revenue has risen only 4% since 2004, from $96 billion to $100 billion in 2010, yet gross margins have risen for seven straight years (to a recent 46%). Meanwhile, EBITDA has risen more than 50% since 2004 to a recent $23 billion, while free cash flow has exceeded $11 billion for three straight years. This prodigious free cash flow has enabled IBM to shrink its share count for eight straight years through ongoing buybacks. Shares outstanding have fallen from 1.72 billion in 2003 to about 1.25 billion currently. These are all the kinds of metrics Buffett can really embrace.

Others have taken note as well. IBM's 28% return so far in 2011 makes it the best-performing stock in the Dow Jones Industrial Average (DJIA) this year. And at almost $190, it's fair to wonder whether following Buffett's move and buying IBM still makes sense.

Most analysts who follow the firm tend to see further upside, although their price targets don't imply major gains. This may be because they assess a company on near-term prospects, while Buffett and many other buy-and-hold investors are much more intrigued by the long-term growth potential.

Here's a quick sample of analysts' views:

-- Smith Barney has a $205 price target, noting "IBM remains on track to deliver $20 in earnings per share (EPS) by 2015, consistent with the company's 5-year roadmap." (2012 EPS are expected to approach $15 a share. If the price-to-earnings (P/E) multiple stays constant, then shares would appreciate 33% during the next four years if IBM hits its profit target).

-- Merrill Lynch, which also has a $205 price target, suggests IBM can keep meeting EPS targets, even in a challenging IT market: "We believe the company is going to embark on further cost-cutting initiatives, given the slowdown in IT spending."

-- Goldman Sachs has a more modest $200 price target and has begun to think about where IBM will head under the direction of incoming CEO Virginia Rometty: "Over time, we believe Ms. Rometty may increase IBM's strategic focus on emergingmarket expansion and business analytics in particular."

Risks to Consider: IT spending may fall in 2012 if Europe heads into recession and the U.S. economy fails to deliver a head of steam. This would make IBM "the best house in a bad neighborhood," likely limiting upside while providing a decent degree of downside protection.

Action to Take -->
Buffett doesn't focus on quarterly results. He likes to focus on where a business model is heading during the coming decade. [StreetAuthority Co-founder Paul Tracy likes to call this approach buying "forever stocks."] That's why Buffett owns (or has owned) companies like Coca-Cola (NYSE: KO), Wells Fargo (NYSE: WFC) and American Express (NYSE: AXP). These stocks all rose, fell and rose again, but made Buffett -- and his investors -- ample profits over the long haul. He sees a similar long-term opportunity with IBM. Otherwise, he wouldn't go to the trouble to spend about $12 billion of Berkshire Hathaway's money.

-- David Sterman

P.S. -- If you're interested in learning more about "forever stocks," then I urge you to watch Paul Tracy's latest presentation, "The 10 Best Stocks to Hold Forever." Click here to learn more.

Disclosure: Neither D. Sterman nor StreetAuthority, LLC hold positions in any securities mentioned in this article.

This article orginally appeared on StreetAuthority.com

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