Buffett Explains Key Math in IBM, Wells Fargo Investments (Correct)
The second is to focus on -- and learn from -- the investment guru's math on how to gain on stock swoons and share repurchases. He laid out this thinking in his annual letter to shareholders on Saturday.
The math applies both to Berkshire's own repurchases of its own shares, and to buybacks by other companies, including IBM, in which Berkshire has invested $10.3 billion.
The key for shareholders in companies with buyback plans is that their stocks underperform. That may look like a contrarian strategy until the math is explained.
In 2011, Berkshire bought back $67 million worth of its stock in a suprise September announcement, increasing the value of the remaining shares held by investors.
But in Saturday's letter to shareholders, Buffett explained the conditions that are necessary for such buybacks to benefit shareholders.
"Continuing shareholders are hurt unless shares are purchased below intrinsic value. The first law of capital allocation -- whether the money is slated for acquisitions or share repurchases -- is that what is smart at one price is dumb at another," wrote Buffett in his letter.
Simply put, Buffett will consider buying back Berkshire shares so long as the company's stock trades at less than 110% of its book value.
In 2011, Berkshire's stock dropped more than 4%, underperforming the S&P 500 . Year to date, the company's shares are up nearly 5% to $120,000.
Currently, Berkshire Hathaway has $37.3 billion in cash on hand, and the company's shares currently trade at about 125% of book value, meaning they're above the buyback threshold right now.
That math is also a key for Buffett's IBM investment and guide for how to invest in non-Berkshire owned stocks.
In the letter to shareholders, Buffett said he hopes IBM's stock price "languishes throughout the five years" that the company engages in a $50 billion share repurchase program.
That's right: He wants the shares of a company in which he's investing to languish!