Warren Buffett is one of the most revered investors on Wall Street. That’s partly because he has amassed a personal fortune of $140 billion, but also because Berkshire Hathaway (NYSE: BRK.A) (NYSE: BRK.B) has grown at a phenomenal pace under his leadership.

The company’s Class A stock has returned 20% annually since Buffett took control in 1965. Meanwhile, the S&P 500 (SNPINDEX: ^GSPC) has returned about 10% annually. Berkshire’s outperformance boils down to prudent capital allocation decisions, and Buffett deserves much of the credit.

He has architected dozens of savvy acquisitions, made many prudent investments, and repurchased company stock in a manner that has undoubtedly created shareholder value. But two recent capital allocation decisions are worth exploring. In the June quarter, Buffett sold 389 million shares of Apple (NASDAQ: AAPL) and he bought $345 million worth of his favorite stock.

Here’s what investors should know.

1. Apple

Berkshire first took a stake in Apple during the first quarter of 2016, and it became the biggest position in the company’s portfolio by the fourth quarter of 2017. Many investors were initially surprised because Warren Buffett had famously avoided technology stocks for most of his career. But he has praised Apple CEO Tim Cook for his extraordinary management on several occasions, and Buffett recently said the iPhone “may be the greatest product of all time.”

Apple still ranks as Berkshire’s largest holding, and Buffett does not expect that to change this year. But his decision to sell 49% of the position in the June quarter raises questions, especially because he had already trimmed the position by 13% in the March quarter. Why would Buffett sell so much Apple stock when he clearly admires the company?

Earlier this year, Buffett was asked that question at Berkshire’s annual meeting, and he attributed the decision to a probable increase in the corporate tax rate in the future. The U.S. federal government has run a historic deficit in recent years, and Buffett believes higher taxes will be used to remedy the situation at some point. In that scenario, Berkshire would pay more taxes on its earnings, and GAAP earnings include investment gains.

In other words, Buffett has been selling Apple stock this year so that Berkshire will not have to pay a higher tax rate on the investment gains in the future. That makes sense, but it raises another question: Why focus on Apple? If corporate taxes increase, Berkshire would owe the federal government a large slice of its investment gains on every stock. So, why is Buffett selling Apple so aggressively? The logical answer is valuation.

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Apple is a wonderful business with enviable brand authority and a strong presence in many markets, including its position as the largest smartphone manufacturer in the U.S. However, Wall Street expects its earnings to increase at 8.6% annually over the next three years, which makes its current valuation of 34.4 times earnings look expensive. Those figure give a PEG ratio of 4, a substantial premium to the three-year average of 2.7.

2. Berkshire Hathaway

Berkshire Hathaway amended its stock buyback program in 2018, such that Warren Buffett can repurchase shares whenever he believes they are discounted compared to their intrinsic value. Buffett allocated $345 million to stock buybacks in the June quarter, bringing the total to $2.6 billion year to date and nearly $78 billion since 2018.

Consistent share repurchases indicate Berkshire stock has regularly been undervalued in Buffett’s estimation. It also suggests that Berkshire is his favorite stock. As my colleague Sean Williams explains, Buffett could have purchased any of 379 companies in the S&P 500 with $78 billion. Alternatively, he could have bought stock in the other 121 companies. Instead, he spent the money on buybacks.

What sets Berkshire apart is the scope of its insurance businesss, coupled with prudent investment decisions made by Buffett and his understudies, Todd Combs and Ted Weschler. To elaborate, Berkshire is the world leader in insurance float — a terms that refers to premiums collected by the company that have not yet been paid out in claims. Moreover, Berkshire has paid “less than nothing” to accumulate float due to disciplined underwriting, according to Buffett.

He once defined float as “funds that do not belong to us, but are nevertheless ours to deploy, whether in bonds, stocks or cash equivalents such as U.S. Treasury bills.” That’s why Buffett loves the insurance business. With disciplined underwriting, it generates large sums of investable capital, and Buffett has used those funds to create substantial value for shareholders.

Berkshire’s book value per share — a good proxy for changes in intrinsic value — increased 194% during the 10-year period that ended in the June quarter. The S&P 500 returned 179% over the same interval. That tells me Buffett and his understudies have invested Berkshire’s float very effectively.

Wall Street expects Berkshire’s operating earnings (which exclude investment gains and losses) to increase at 17% annually through 2027. That consensus estimate makes the current valuation of 23.3 times operating earnings look reasonable. Patient investors should feel confident in buying a small position in Berkshire today, especially because Buffett is probably repurchasing shares in the current quarter.

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Trevor Jennewine has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Apple and Berkshire Hathaway. The Motley Fool has a disclosure policy.

Warren Buffett Just Bought $345 Million of His Favorite Stock (Hint: Not Apple) was originally published by The Motley Fool