This is the fourth article in a case study series related to our valuation of and investment in IBM. You can find the earlier articles in the series through these links: Intro, Options, Valuation. The centerpiece of this article is a PDF – which is embedded below – comparing our valuation driver forecasts for IBM over the last two years to its actual results.
Every convenience you enjoy – from the warm shower you took this morning to the device on which you are reading this article – has been made possible through the application of the scientific method to the natural gift of human curiosity.
At the heart of the scientific method is the process of forming a hypothesis and observing how that hypothesis holds up against actual results in a process of careful testing. As we form more hypotheses and test them successfully, we have more confidence that we understand how the world works and can describe it accurately.
Since the scientific method has been so successful in advancing and improving our lives, why should we not take advantage of it to make decisions about saving and investment? Why not take a scientific approach to valuing and investing in IBM, for instance?
We have followed IBM closely for two years and have invested in it over this time. During this time, we have made and subsequently tested our hypotheses regarding IBM’s value drivers:
- Revenue Growth
- Profitability
- Investment Level
- Medium-term Growth
Through this process of hypothesis testing, we have become more confident that our understanding of IBM is correct and that our conception of its likely intrinsic value range is accurate.
With this confidence, we felt secure in accepting IBM’s downside price risk to receive a monetary premium as detailed in our article Options Offer More Options.
Warren Buffett invested in IBM in 2013 – a few years earlier than we did. When he announced that he had made a mistake in this investment and subsequently disinvested from IBM, I would be lying if I said I did not have second thoughts about my own judgement. The main factor that allowed me to stay in the position – a position that has generated nice returns throughout – was that I could see that my forecasts were turning out as I had expected and consistently led to the conclusion that IBM is likely undervalued.
I believe that anyone can do exactly the same as I have: disregard the advice or actions of a guru and rely upon one’s own insight and observations. All one needs is a sound framework for making decisions!
We will discuss the form our investment has taken in the next article (we have mainly sold options on it) and our portfolio management of the position (which started small and tentative and has increased in size over time).
To show you the how the scientific process plays out in investing, I am embedding a PDF copy of an article that we published for Framework members after IBM’s first quarter earnings that compares our forecasts to IBM’s results over the past few years. This is a real-life example of applying the scientific method to investing!
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