Tuesday, November 15, 2011

Buffett Makes a Value-Growth Bet


I.B.M. slips easily into the Warren E. Buffett investment pattern. His reputation was built on such stocks. Somewhat overlooked, the technology-turned-consultancy company — in which Berkshire Hathaway has amassed an $11 billion stake — has a likeable mix of growth and value qualities.

We don’t know how Mr. Buffett reached his decision to invest in Big Blue. It is not a simple case of bargain hunting, though. Berkshire Hathaway built its stake over the last eight months, when I.B.M.’s share price climbed steadily. But the investment could have been made more cheaply in 2010.

At current levels, shares trade at a premium to the market. Using the Thomson Reuters Starmine database, the global average forward price-to-earnings ratio is 12. I.B.M. trades on a comparable multiple of 14. I.B.M. stock is hardly cheap when judged in terms of dividend yield, either. The world average is 2.8 percent, according to Starmine. I.B.M. gives investors 1.5 percent.

Nor does I.B.M.’s earnings outlook set it far apart from the crowd. Analysts’ consensus opinion, according to Starmine, is that I.B.M. will increase earnings 11 percent over the next 12 months. Yet 87 of the world’s 200 largest quoted companies are expected to increase earnings at rates of more than 10 percent over the same period.

There are relatively few companies, however, that offer a mix of growth and value attributes similar to those of I.B.M. Even fewer can demonstrate the cash flow characteristics needed to give investors assurance about the sustainability of dividend payments.

In fact, only four of the top 200 quoted companies match I.B.M. on these growth and value measures. Each is reckoned to be capable of increasing earnings at least 10 percent next year and has at least a threefold cash flow cover for its dividend.

Like I.B.M., the other four are regarded highly enough by investors to have forward price-to-earnings ratios of 13 to 15. All four also give a yield of 1 to 2 percent. For budding emulators of the Buffett style, they are Caterpillar, Comcast, Coal India and CVS Caremark.

Sarbanes-Oxley Test

MF Global could finally help the Sarbanes-Oxley Act prove itself. The reform inspired by Enron, WorldCom and other accounting scandals helped clean up company books in the United States, albeit at a cost. But approaching 10 years on, the law has had few cases filed under it. The enforcers could finally get their big chance if questions surrounding MF Global’s failure prove to have substance.

Sarbanes-Oxley has always drawn complaints. A 2009 survey by the Securities and Exchange Commission pegged the average company’s cost of complying with the 2002 law at $2.3 million a year. Some firms complained that it deterred them from going public and drove business overseas. More recent research, in contrast, credits the law for better disclosure, fewer financial restatements and a lower cost of capital for companies.

Either way, the law has lacked muscle. Executives who certify books that turn out to be questionable can be forced to return bonuses and other incentive pay. The S.E.C. has filed cases against 31 executives at 20 firms. But only tiny amounts have been collected since the financial collapse, despite glaring failures, and about the only sizable names involved were Navistar, Diebold and Beazer Homes.

The HealthSouth chief, Richard M. Scrushy, was prosecuted for signing a false financial statement, and a California man under investigation for child pornography was convicted of destroying his computer hard drive — a violation of Sarbanes-Oxley. Criminal cases, though, have been scarce.

One reason is that the law overlaps with some prohibitions in older statutes and those, already tested in the courts, may be preferred by enforcers. Regulators may also be wary of action that involves going after auditors, since the prosecution and collapse of Arthur Andersen left companies with few big accounting firms to choose from.

But MF Global is shaping up as a highly visible potential candidate. Bart Chilton, a commissioner at the Commodity Futures Trading Commission, on Tuesday suggested that activities at the firm — where $600 million in customer funds still seem to be missing — could have been illegal. Critics have pummeled law enforcement for timidity toward financial crime and Sarbanes-Oxley for being all bark and no bite. Using the law to go after MF Global could show both have teeth after all.

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