I used to think that if I hold stocks in my portfolio and if the price continue to rise it’s good for my portfolio. It still holds true as I can sell it higher at anytime and pocket the gains (minus the taxes etc as applicable). However, when I was looking at Mr Buffett’s holding IBM to find out if I should start buying it as the prices are lower vs what Warren Buffett paid, I re-discovered this interesting perspective –
Here is how Warren Buffett invested in IBM–
Buffett began to buy IBM shares in the first quarter of 2011, with 4,517,774 shares for a price of $159 on average. Purchasing became more aggressive in the second and third quarter when he cumulatively bought more than 82.2 million shares for $167 and $173 on average. From the fourth quarter of 2011, to the third quarter of 2012, he made smaller purchases at average prices ranging from $185 to $197. By the end of the third quarter, he owned a total of 67,517,896 shares, which equals 5.98% of IBM’s shares outstanding. It also made the company an 18.6% weighting in Buffett’s portfolio (source – Forbes).
As of last reporting, Berkshire owns 70,478,012 shares of IBM. The average price is estimated at ~$188. Current market price is $155.
So why Mr Buffett will really be pleased with fall or sideways pricing, Mr Buffett provides the answer himself.
“We should wish for IBM’s stock price to languish throughout the [next] five years,” Buffett wrote in Berkshire’s 2012 letter to shareholders. IBM is known to spend a lot of money on share buybacks, so it only makes sense to wish for lower share prices while that train is rolling.
“The logic is simple,” Buffett wrote in 2012. “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.”
Interesting logic. The combination of IBM’s shrinking share count and Berkshire’s further investments in the stock will result in far higher ownership stake for Mr Buffett’s company.
So, Is your company buying back shares thus reducing the numbers of shares outstanding? It seems that’s the key driver here for being pleased with the sideways or pullback of prices…
The next logical question is – Warren Buffett’s price was $188 on average, current share price is $155 and Mr Buffett doesn’t seem to be liquidating IBM, should I invest? Should I follow him?
As a retail trader with smaller capital base, we do have some alternatives though:
- Buy just plain shares: At $155 each, 1000 shares will cost U$155,000
- Buy 12 deep in the money call options e.g. Jan 2017 120 Call options (80 delta) for $40 each and thus investing almost $48,000 and participate in the potential upside (be aware though that you are also paying $10% of this cashflow for the time value).
- 3rd options is to sell naked put for your chosen price and time. You may choose many combos.
- Or simple own long term and sell shorter term options.
[If you are in Singapore on 14th May, 2016 (Saturday), we are conducting a live training full day workshop (for FREE) and will teach this in more details. Click here to be on the list so you can receive priority notice as soon as we open it for registrations]
Bottomline – There are numerous choices; HOWEVER, the key decision is “do you want to follow Mr Buffet for his IBM decision”? I would personally flow with it and use the best combination of options strategies with bullish bias, managing risk in a way that doesn’t jeopardize my whole account. Selling naked puts does offer an interesting risk/reward vs other strategies in the current environment due to relatively higher IVs .
What do you think?
Disclaimer : As of this writing I don’t have positions on IBM and I have rounded-off the prices above for the simplicity of calculation.