Why Warren Buffett Backed Up the Truck on Apple (AAPL) Stock

Most of the “Warren Buffett buys Apple stock” stories this week have reflected a sense of surprise that the world’s most famous value investor nearly quadrupled his holdings in the tech icon in the last three months of 2016.

But the answer is actually simple. Apple is a household name, a well-run company, a company he understands, and the stock is trading at a reasonable price.

Still, Wall Street is skeptical…

“I’m stunned to see the size of that Apple position,” Thomas Russo, a partner at investment firm Gardner Russo & Gardner, told Reuters.

As of Dec. 31, Berkshire Hathaway Inc. (NYSE: BRK.A, BRK.B), the holding company Buffett has controlled since 1964, owned 57.4 million shares of Apple Inc. (Nasdaq: AAPL). At the end of the previous quarter, Berkshire owned just 15.2 million shares.

With the Apple stock price at about $135, Berkshire’s stake is worth nearly $7.75 billion. Berkshire is now among AAPL’s 10 largest investors.

Wall Street was taken aback at first because Buffett historically has shunned large stakes in companies that disrupt industries, and tech companies in particular.

Buffett’s core holdings tend toward such tried-and-true companies as Coca-Cola Inc. (NYSE: KO) and Wells Fargo & Co. (NYSE: WFC).

Apple just doesn’t fit the profile for a Warren Buffett stock pick.

Or does it?

When you take a closer look at Apple, you realize that it’s evolved into a company that fulfills virtually all of Buffett’s investing criteria…

Warren Buffett Buys Apple Stock Because It’s a Perfect Fit

Five years ago, Apple was still a high-flying growth stock. But the company’s tremendous size – it has the largest market capitalization in the world, more than $700 billion – and the maturation of its key business, the iPhone, have transformed AAPL into more of a value stock.

And when you consider the things Warren Buffett looks for in a target stock, Apple is a surprisingly good match.

Take a look…

Warren Buffett Principle No. 1: Buy Household Names

Even non-investors recognize the companies in Buffett’s portfolio – and that’s the point. He knows that a powerful brand name helps a company retain market share and future earnings.

Apple has one of the most recognized brands in the world, often ranking first in lists of brand value. Everywhere you go, you see people holding their iPhones.

In fact, Apple products are as common as the products by such Berkshire holdings such as The Kraft Heinz Co. (NYSE: KHC) or General Motors Co. (NYSE: GM).

Warren Buffett Principle No. 2: Buy What You Understand

This rule is why Buffett has for the most part avoided tech stocks. But Apple products are used by almost everyone now, from children to senior citizens. It’s not just Apple, of course. It’s hard to find an American that doesn’t own some sort of smartphone or PC.

Apple, in many respects, is now a consumer staple stock.

Think about it. At one time, autos and air travel both could have been considered “tech stocks” – a notion that seems absurd today. (Buffett likes them as well, having stakes in one automaker and four airlines.)

Warren Buffett Principle No. 3: Buy Well-Run Companies

The actual wording of this Buffett rule says a target company should be “operated by honest and competent people.”

Apple has a great track record in that regard. Most of the top management team has been on board since the early days of Apple’s revival in the late 1990s. It’s a very stable, talented group that does its best to carry on in the tradition of its late great visionary, Steve Jobs.

Warren Buffett Investing Principle No. 4: Pay a Reasonable Price

Apple stock is trading near an all-time high now, but back in October and November when Buffett was buying, AAPL was trading between $106 and $118. Its price/earnings ratio was under 14, well under the Standard & Poor 500 average of just over 20.

With sales of the iPhone 6s models disappointing Wall Street, sentiment on AAPL was decidedly negative. Apple stock wasn’t going to crash, but last fall it could be had at something of a discount.

But here’s why we think Warren Buffett decided to back up the truck…

Warren Buffett Principle No. 5: Buy Profitable Companies

This seems like a no-brainer until you recall how many investors piled into money-losing stocks during the dot-com bubble. Buffett knows that results, not hype, should be the basis of investing decisions.

Buffett typically likes to see a company with predictable and proven earnings for at least the previous 10 years. Apple’s net income has skyrocketed over the past decade, from about $2.4 billion in 2006 to $45 billion last year. Free cash flow was $52.4 billion. And Apple is sitting on $246 billion in cash.

And while Apple has added debt in recent years to fund its share buyback program and dividend payouts, its torrential cash flow more than offsets it.

Apple’s dividend yield of 1.69% doesn’t hurt, either, particularly since the company has plenty of leeway to raise it in the future.

Warren Buffett Principle No. 6: Buy Companies That Have a “Moat”

Buffett often speaks of the value of an “economic moat.” By that he’s referring to the ability of a company to fend off competition. Companies with a strong moat tend to have higher profit margins.

Apple has plenty of competition, but as a premium brand it has unmatched pricing power. It maintains gross margins in the 37% to 39% range.

That’s unheard of in Apple’s two main markets, PCs and smartphones. Last November, BMO Capital Markets estimated that the iPhone took in 103.6% of the smartphone industry’s operating profits – a figure made possible by the losses of its rivals.

–David Zeiler


Source: Money Morning