Why Warren Buffett Is Such A Big Fan Of Apple

Why Warren Buffett Is Such A Big Fan Of Apple
Carl Hazeley

about 2 years ago3 mins

  • Warren Buffett identified Apple as one of Berkshire Hathaway’s key giants.

  • Berkshire Hathaway may be attracted to how cash-generative Apple is, and how much more cash it’ll make as services become a bigger part of the business.

  • It’s becoming a more defensive stock too, but it’s also more expensive than its rivals, and offers lower earnings growth to boot.

Warren Buffett identified Apple as one of Berkshire Hathaway’s key giants.

Berkshire Hathaway may be attracted to how cash-generative Apple is, and how much more cash it’ll make as services become a bigger part of the business.

It’s becoming a more defensive stock too, but it’s also more expensive than its rivals, and offers lower earnings growth to boot.

Mentioned in story

In his recent annual shareholder letter, Warren Buffett drew attention to Berkshire Hathaway’s “giants”: four investments that “account for a very large chunk of Berkshire’s value”. And it’s Apple that takes the second spot in the ranking, even though its sky-high valuation is arguably at odds with its potential profit growth. So here’s why Berkshire may be sticking with the iPhone-maker through thick and thin, and whether you should too.

What’s Apple’s business model?

Buffett famously said he didn’t invest in tech companies because he didn’t understand them. But since his capable deputies – who have taken more and more control of Berkshire’s investment decisions – do, the investment juggernaut has built up a significant holding in Apple. In fact, Berkshire’s 5.6% holding represents 44% of its stock portfolio.

Source: CNBC.
Source: CNBC.

Apple’s business model has historically been pretty simple: it sells tech hardware like iPhones, iMacs, iPads, Macbooks, and Apple Watches. In the last few years, though, the company’s shifted its focus to a “services” segment that includes the App Store, Apple Music, TV+, and more. Only a quarter of Apple device owners were paying up for at least one of those services back in 2018, but that figure’s probably risen since: the segment’s revenue grew from $40 billion in 2018 to almost $70 billion last year, after all.

As for why the growth in services revenue is so important: profits. Apple’s physical products generate a gross margin of 35%, while its services generate a 70% gross margin. All else equal, then, the greater the proportion of revenue that comes from services (approximately 20% now), the greater Apple’s profit margin – meaning higher earnings and more cash. And it’s that cash, I reckon, that Berkshire Hathaway’s particularly interested in…

What does Berkshire like about Apple?

Last year, Apple paid out about 15% of its earnings as dividends, which was 7% higher than the year prior and up 9% a year on average over the last five years. Of course, it wasn’t much in the grand scheme, representing just 0.54% of Apple’s total market value. But when you’re as big a shareholder as Berkshire Hathaway, that’s nothing to sniff at: the firm received $785 million in Apple dividends last year.

Still, by his own admission, Buffett’s most excited by Apple’s share buybacks. See, by using its existing cash to repurchase its own shares, Apple reduces the supply shares available and boosts the price of those that are left (since Apple’s overall value won’t have changed). It’s an efficient way to reward investors, given that share buybacks don’t typically attract the same taxes as dividend income.

What’s more, investors who hold onto their shares through a buyback see their proportional ownership in the company increase. So this year, Berkshire will receive an even higher proportion of Apple’s dividends, driving a virtuous circle of income and capital appreciation for the investment manager.

“Here, our ownership is a mere 5.55%, up from 5.39% a year earlier. That increase sounds like small potatoes. But consider that each 0.1% of Apple’s 2021 earnings amounted to $100 million. We spent no Berkshire funds to gain our accretion. Apple’s repurchases did the job.”

Warren Buffett, Berkshire Hathaway 2021 annual shareholder letter

So should you “buy with Buffett”?

Almost all investors keep an eye on what Berkshire Hathaway is buying and selling, and some even blindly follow the Oracle of Omaha’s firm wherever they can.

And there are plenty of reasons to follow Berkshire into Apple right now. For one thing, the company’s becoming less cyclical and more defensive thanks to its increasing proportion of services revenue. That helps make the company’s earnings more predictable, since subscriptions to things like Apple Music tend to be pretty sticky. And of course there’s Apple’s growing dividend, which – if the stock price takes a tumble – becomes even more attractive relative to the company’s valuation.

But speaking of its valuation, that’s the one good reason not to invest in Apple right now. Apple’s shares currently trade at a price-to-earnings ratio of 26.7x – above the average of global tech stocks at 22.4x. Apple’s simultaneously expected to deliver lower-than-average sales and earnings growth over the next year compared to those peers, suggesting its valuation premium to other tech giants may not be warranted.

Apple’s trading at a premium to peers despite lower sales and earnings growth.
Apple’s trading at a premium to peers despite lower sales and earnings growth.

So absent a meaningful positive surprise from Apple’s earnings updates, its share price may come under pressure this year. Then again, Apple has a track record of beating expectations, making it hard to write off the tech giant just yet…

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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