Buffett Explains Key Math in IBM, Wells Fargo Investments (Correct)

This article has been corrected to show that Berkshire Hathaway's shares currently trade at about 125% of book value. The original article stated that the company's shares trade at a bit more than 80% of book value. TheStreet regrets the error.

NEW YORK ( TheStreet) -- For those looking to use Warren Buffett-run Berkshire Hathaway's ( BRK.A) investment strategy to bolster their portfolios, there are two options.

The first is to simply copy his recent investments in IBM ( IBM) and DirecTV ( DTV), as well as his boosted stake in Wells Fargo ( WFC).

Warren Buffett

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.

Content on this page requires a newer version of Adobe Flash Player.

Get Adobe Flash player

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.

For more on Warren Buffett's investments, see Berkshire Hathaway's portfolio. For more on his investing strategy, read Warren Buffett's 8 investing commandments.

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.

If you liked this article you might like

How to Get Rich Using Warren Buffett's Favorite Stock Market Indicators

How to Live Just Like Billionaire Warren Buffett

How to Make a Deal Like Billionaire Investor Warren Buffett

How to Invest Like Billionaire Warren Buffett

How to Eat Lunch With Billionaire Warren Buffett