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IBM Buyback Proves Warren Buffett's Math

Here's the why Buffett is banking on a flat share price for IBM in coming years.

As of Berkhsire's 2011 shareholder letter, IBM had roughly 1.16 billion shares, 63.9 million of which are owned by Buffett in a 5.5% shareholding, at the time.

Buffett expected the value of his investment to rise significantly as the company conducts its five-year, $50 billion share repurchase program.

Under the program, if IBM shares were to languish at prices around $200, which they have, IBM will buy back about 250 million shares, putting Buffett's stock ownership closer to 7%, as the company's share count shrinks to 910 million shares.

But if IBM shares were to rise to say $300 a share, Buffet's stake would only be 6.5% on a share buyback of just 167 million shares.

Of course, the benefit of owning shares -- regardless of buyback programs -- is contingent on a company's earnings prospects, and that's where Buffett's strategy kicks in.

If IBM were to earn $20 billion in the year its buyback expires, and its shares are still trading at $200, Buffett said Berkshire's share of the earnings will be $100 million more than if shares trade at $300.

"At some later point our shares would be worth perhaps $1.5 billion more than if the 'high-price' repurchase scenario had taken place," wrote Buffett of the impact to Berkshire's earnings.

"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," wrote Buffett in the 2011 letter.

So far, Buffett's analysis and his expectations have been remarkably accurate. Berkshire's economic interest in IBM has grown materially as the company repurchased shares through 2012. Berkshire also added to its IBM investment in recent quarters .

Were IBM to exhaust its 2013 buyback, which now stands at $11.2 billion, the company would end the year with about 1,068,000 shares, down about 8% from when Buffett made his comments in February of 2012.

Meanwhile, IBM paid out 85 cents a quarter in dividends in 2012 and now expects to make a 95 cent quarterly payout this year. Berkshire received over $200 million in cash from IBM, just from dividend payments in 2012.

Buffett, however, isn't likely to attribute his prescience on IBM's share buyback and the company's flat share prices to any personal genius.

"In my early days I, too, rejoiced when the market rose. Then I read Chapter Eight of Ben Graham's The Intelligent Investor , the chapter dealing with how investors should view fluctuations in stock prices," wrote Buffett in the 2011 shareholder letter.

"Immediately the scales fell from my eyes, and low prices became my friend. Picking up that book was one of the luckiest moments in my life."

-- Written by Antoine Gara in New York

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