Warren Buffett made a big and unexpected move in 2011, when he decided to take a big position in International Business Machines Corp. (NYSE:IBM) and make the IT company one of Berkshire Hathaway Inc. (NYSE:BRK-B) “big four” holdings alongside names like The Coca-Cola Company (NYSE:KO), Wells Fargo & Co (NYSE:WFC) and American Express Company (NYSE:AXP).
The stock is basically flat over the last year, seriously lagging the Dow Jones Index, which is up by nearly 20% in the same period. But Buffett is most likely not feeling any regrets for his purchase, on the contrary, he must be rejoicing as his investment in IBM becomes more valuable in the long term due to short-term price weakness.
In his 2012 letter to shareholders, Warren Buffett recommends the book The Outsiders, by William Thorndike, described by the Oracle as “an outstanding book about CEOs who excelled at capital allocation.”
Berkshire Hathaway Inc. (NYSE:BRK-B) is one of the companies profiled in the book, which comes as no surprise considering that Buffett is one of the best capital allocators in corporate history. Buffett didn´t achieve his amazing success by running a specific business in a certain industry, his big talent is capital allocation, and that´s what makes Berkshire so special.
The insurance business is at the core of Berkshire Hathaway Inc. (NYSE:BRK-B)´s business model, not only because it brings in a big proportion of earnings but, more importantly, because it generates low cost float which Buffett allocates in different investments with attractive risk and return profiles. In a nutshell, what Buffett does with Berkshire is raising cheap capital and putting it to work in high quality investment opportunities, capital allocation at its best.
When a company has surplus cash, and the stock price is attractive enough to merit that decision, investing in its own stock via buybacks may be the right thing to do in terms of efficient capital allocation.
That´s why Buffett has established a simple and smart buyback policy for Berkshire Hathaway Inc. (NYSE:BRK-B): the company will repurchase stock provided it has more than $20 billion in cash at hand and the stock is trading at an attractive valuation, which Buffett has defined as a price to book value ratio below 1.2.
In Berkshire Hathaway Inc. (NYSE:BRK-B)´s 2011 letter to shareholders, Buffett explains that capital allocation has been a major consideration behind the decision to invest in IBM. The Oracle praises CEOs Lou Gerstner and Sam Palmisano for their operational skills, transforming IBM from a decaying company to a major global IT player, and he then focuses on capital allocation: