See why Buffett (or one of Berkshire's other portfolio managers) invested in Apple – and how it differs from the traditional Buffett investment
Warren Buffett (Trades, Portfolio)’s newest 13F filings were releasedrecently.
The Oracle of Omaha has invested in another tech company. This is only Buffett’s second large technology company investment. The first came in 2011.
That’s when Warren Buffett (Trades, Portfolio) began building a position in IBM (NYSE:IBM). Today, IBM is Berkshire Hathaway’s (NYSE:BRK.A) fourth-largest holding – 9.6% of the company’s total stock portfolio.
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- AAPL 15-Year Financial Data
- The intrinsic value of AAPL
- Peter Lynch Chart of AAPL
Buffett famously (prior to 2011) avoided tech stocks. When asked in the late 1990s if he was (at the time) investing in technology stocks, Buffett said the following:
“The answer is no, and it’s probably unfortunate. I don’t know what that world will look like in 10 years, and I don’t want to play in a game where the other guy has an advantage over me.”
Buffett appears to have studied up on technology stocks since the late 1990s. It is interesting to note that he only invested in IBM when it:
- Traded at a low price-to-earnings multiple.
- Paid a dividend.
- Heavily engaged in share buybacks.
His recent investment in Apple (NASDAQ:AAPL) follows the same pattern. Apple is currently trading for a price-to-earnings ratio of 10.5 and has a 2.4% dividend yield and a $175 billion (yes, you read that right) share repurchase program in place.
Did Buffett really invest in Apple?
There’s no doubt that Buffett was behind the IBM investment. It makes up nearly 10% of his portfolio.
In Buffett’s 2015 annual report, he gave an update about the control both Todd Combs and Ted Weschler have over Berkshire’s (NYSE:BRK.B) portfolio:
“Todd (Combs) and Ted Weschler are primarily investment managers – they each handle about $9 billion for us – both of them cheerfully and ably add major value to Berkshire in other ways as well. Hiring these two was one of my best moves.”
With a combined portfolio value of around $18 billion, it is conceivable that the Apple investment came from Weschler and/or Combs.
Regardless, Berkshire Hathaway has invested a bit over $1 billion in Apple stock. This makes up around 0.8% of Berkshire’s total portfolio.
What is strange about Buffett’s Apple investment
If you look at Buffett’s portfolio, you will see it is filled with high quality businesses with long histories of success.
These are businesses that have proven they can grow and prosper over the long run. The founding date of his top five holdings (which make up 69% of his total portfolio) are discussed below:
Kraft-Heinz Company (NASDAQ:KHC): The company was recently created through a merger. Kraft traces its history back to the late 1800s and early 1900s:
- James L. Kraft started his cheese business in 1903.
- C.W. Post started Postum Cereal in 1895.
- Oscar Meyer started his meat business in 1883.
International Business Machines: IBM traces its roots back to 1911. It began life by the less grandiose name of Computer-Tabulating-Recording-Company.
American Express (NYSE:AXP): American Express is the oldest of the five, tracing its history all the way back to 1850.
The average founding year of Buffett’s top five holdings is 1876 – the same year the first telephone call was made.
Looking at these holdings, it is clear Buffett looks for a very long history of sustained success. This is where Apple does not fit the traditional Buffett stock.
Apple was founded in 1976. The company does not have a sustained history of success. In 1997, Apple was bailed out of bankruptcy by a $150 million investment from Microsoft (NASDAQ:MSFT).
Apple did not become the Apple we know today until 2001, when the first iPod was released. The iPod’s success launched the iPhone, iPad, iTunes and Apple Watch.
Apple did not become the Apple we know today until 2001, when the first iPod was released. The iPod’s success launched the iPhone, iPad, iTunes and Apple Watch.
Today, Apple is the largest corporation in the world based on both market cap and earnings:
- $518 billion market cap.
- $50.7 billion (!) in earnings over the last 12 months.
But Apple’s success is recent and came quickly. It does not match the slow gradual growth of Buffett’s other large holdings.
This makes me think that the Apple investment is a large bet (relative to the size of the portfolio they control) by either Combs or Weschler.
Apple is a high quality shareholder-friendly business
I look for high quality dividend growth stocks suitable for long-term holding. There’s no doubt Apple is a high quality dividend growth stock today.
Apple reinstated its dividend in 2012 (the company hadn’t paid a dividend since 1995). The company’s dividend history is shown below:
What’s more, the company has repurchased over 5% a year on average of its shares each year from 2012 through 2015.
Apple currently has a dividend yield of 2.4%. The company’s dividend yield combined with its share repurchases gives it a shareholder yield of around 7.5% – which is extremely high. There’s no doubt Apple is a shareholder-friendly company.
Apple’s ability to generate cash – $50 billion in earnings over the last 12 months – makes it very clear the company has a strong brand-based competitive advantage.
The company’s products and brand represents quality. Apple’s products greatly improve the lives of hundreds of millions of people.
What isn’t clear about Apple is the sustainability of its competitive advantage.
Will we be using credit (American Express), eating Ketchup (Kraft-Heinz) and drinking beverages (Coca-Cola) in 10 years? With a very high degree of certainty, you can say yes to all of the above.
Will Apple still be the world’s dominant smart phone company in 10 years? What about 20 years? Will we even use smart phones in 20 years? The answer to those questions are much less certain.
That’s where the uncertainty in an Apple investment lies. It’s not whether the company is shareholder friendly and has a strong competitive advantage today (it most certainly does. It is about whether that competitive advantage is durable and sustainable.
Apple’s valuation and final thoughts
One thing is clear about Apple stock. The market has priced in fears about the company’s future. Apple is currently trading for a price-to-earnings ratio of 10.5 and a forward price-to-earnings ratio of 10.3
The fears outlined in this article are just as applicable to Netflix (NASDAQ:NFLX), Alphabet(NASDAQ:GOOG) and Facebook (FB) as they are to Apple. The forward price-to-earnings ratios of those three businesses (all of which have strong competitive advantages today) are shown below:
- Alphabet has a forward price-to-earnings ratio of 18.1.
- Netflix has a forward price-to-earnings ratio of 84.9.
- Facebook has a forward price-to-earnings ratio of 26.0.
Apple stock is heavily discounted today. There’s little doubt the company’s brand-based competitive advantage will be sustained over the next several years.
At a price-to-earnings ratio of 10.5, Apple makes an excellent value investment for investors with a medium (say two- to three-year) time frame. When investor sentiment around Apple changes (and it likely will at some point), those who purchased Apple at a price-to-earnings ratio of 10.5 should see large gains.
Does Apple offer above-average risk-adjusted return potential over the next several years? Absolutely.
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