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Apple: Is This Favorite Warren Buffett Stock a 'Buy'?

Apple: Is This Favorite Warren Buffett Stock a 'Buy'?
(Mikhail Primakov/Dreamstime)

By Wednesday, 21 August 2019 12:55 PM Current | Bio | Archive

Warren Buffett is the world’s greatest investor, but his massive success did not happen by accident.

Buffett and business partner Charlie Munger primarily focused their investments on companies offering a wide moat. This means that they purchased shares of companies that enjoyed durable competitive advantages, often with products that consumers could not do without. A strong economic moat helps keep competitors at bay while protecting the business in the event of a recession.

Looking at Berkshire Hathaway’s (BRK.A) most recent 13F filing, you’ll find stocks of companies that are among the most dominate businesses in their sector. These companies also return large amount of capital to shareholders.

Buffett’s largest holding is now Apple (AAPL). This article will discuss why the Oracle of Omaha has increased his stake in Apple stock over the past several months.

Buffett and Tech Stocks

Buffett has mostly avoided technology stocks for most of his career because he felt the sector changes too rapidly for long-term investment. Fearing he didn’t understand technology enough to make informed decisions, Buffett simply chose to invest elsewhere.

That changed when Buffett added IBM (IBM) to his portfolio in 2011. While Buffett has since exited the IBM position, Apple has become the largest component of the Berkshire Hathaway portfolio.

While the initial position was started in 2017 by investment managers Todd Combs and Ted Weschler, Buffett has pushed for additional purchases. In fact, Apple is now Berkshire Hathaway’s top holding and now accounts for 23.74% of the total portfolio.

The reason Buffett changed his mind when it comes to technology stocks is Apple’s wide moat.

Apple Has a Very Wide Moat

Apple produced revenues of nearly $54 billion in its fiscal 2019 third quarter. $50+ billion in revenue would make a great year for most companies, but Apple has failed to reach at least this level just four times since the start of fiscal 2015.

The company did see an 11.8% decline in iPhone sales in the most recent quarter, but had strong gains across the rest of its product portfolio. Services, Wearables, iPad and Mac had revenue growth of 12.6%, 48%, 8.4% and 10.7% respectively.

Just a few quarters ago, iPhones contributed the vast majority to Apple’s sales. iPhones accounted for just 48% of sales in the most recent quarter. This shows that the company is now more than just a phone company.

Apple has also done a masterful job of integrating all of their products, creating an ecosystem that has a very high retention rate among customers.

Apple also has returned a massive amount of capital to shareholders over the years. After reinstituting its dividend in 2012, the company has grown its dividend more than eight-fold. This dividend growth helps make up for the stock’s 1.5% yield. In addition, Apple has retired approximately a quarter of its share count over the last six years.

Expected Returns Going Forward

Just because Buffett has a large position in Apple doesn’t mean retail investors should buy at any price.

Though the company has posted impressive growth over the years (almost 30% from 2009 through 2018), we anticipate that EPS growth will slow to 5.5% through 2024 due to declining iPhone sales.

Shares of Apple trade at $213 at the moment. Using our expected EPS of $11.70 for fiscal 2019, the stock has a P/E ratio of 18.2. This is well above the 10-year average P/E of 13. We have a 2024 target P/E ratio of 15 due to the company’s balance sheet and dominance in its industry.

However, if the valuation were to revert to our fair value target by 2024, this would reduce annual returns by 3.8% over this period of time.

Apple’s annual returns would consist of the following:

  • 5.5% EPS growth
  • 1.5% dividend yield
  • 3.8% valuation compression

In total, we expect Apple to offer a total annual return of just 3.2% through 2024. The company should continue to grow earnings and pay its dividend, but the stock appears overvalued right now.

Final Thoughts

Buffett has done a reversal on technology stocks in recent years and has made Apple the largest holding in his portfolio. While the Oracle of Omaha has an excellent track record and we feel that Apple has been a great stock to own over the years, we feel that shares are too expensive at the moment. Apple receives a hold rating from Sure Dividend due to low expected total returns over the next five years.

Ben Reynolds is CEO of Sure Dividend. Sure Dividend helps individual investors build high quality dividend growth stock portfolios for the long run.

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Warren Buffett is the world’s greatest investor, but his massive success did not happen by accident.
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Wednesday, 21 August 2019 12:55 PM
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