International Business Machines Corp. (IBM), Berkshire Hathaway Inc. (BRK-B): A Surprising Reason Why Warren Buffett Must Be Happy

“I can think of no major company that has had better financial management, a skill that has materially increased the gains enjoyed by IBM.”

IBM puts profitability and cash flow generation above sales growth, it´s not about size but about generating value for shareholders. Since 1995, the company has reduced its share count by almost 50%; this means that the pie is sliced in fewer pieces, so each piece is worth much more.

The company announced in April a 12% dividend hike and a 5 billion increase to its share repurchase program, boosting the company’s total authorization to $11.2 billion. Generous capital distributions are not only a healthy tradition at IBM, but an active policy with strong implications for investors in the middle term.

Here is where things become quite interesting: the cheaper the stock price, the more shares the company can repurchase with a determined amount of money. The long-term investor benefits from lackluster stock returns in the short term because this means that the company gets to repurchase a bigger amount of stock at convenient prices.

In his 2011 letter to shareholders, Buffett explains this idea in all clarity, using precisely IBM as an example:

Naturally, what happens to the company’s earnings over the next five years is of enormous importance to us. Beyond that, the company will likely spend $50 billion or so in those years to repurchase shares. Our quiz for the day: What should a long-term shareholder, such as Berkshire, cheer for during that period?

I won’t keep you in suspense. We should wish for IBM’s stock price to languish throughout the five years.

The logic is simple: 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.

Bottom Line

When a company like IBM has a big and active buyback program, a languishing stock price means that the company gets to buy a bigger amount of stock for every dollar invested in the repurchase, and this ultimately means higher returns for investors in the long term. That´s why Warren Buffett must be quite happy with a stagnant stock price for IBM in the last year.