Why Doesn't Berkshire Just Buy More Apple?

 | Oct 11, 2017 | 6:00 AM EDT
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Berkshire Hathaway (BRK.A) (BRK.B) still has a hefty wad of cash in its pocket (nearly $100 billion at the close of the second quarter), and Warren Buffett continues his search for ways to spend it.

Last week, Berkshire Hathaway announced a deal to purchase around 40% of Pilot Travel Centers LLC -- one of the largest private companies in the U.S. and operator of Pilot and Flying J travel centers -- for an undisclosed amount. The Wall Street Journal called the deal "Berkshire's latest wager on traditional forms of transportation and U.S. economic growth." This on the heels of the summer's foiled plan to purchase power-transmission company Oncor for $9 billion (Sempra Energy swooped in with a higher bid). Earlier in the year, the $15 billion Berkshire committed for Kraft-Heinz's (KHC) purchase of Unilever (UN) unraveled. But Buffett isn't giving up.

But as Buffett continues to hear the hoofbeats of his shareholders, should he perhaps be thinking horses, not zebras? Why not, for example, beef up his stake in a company he already owns? One that readily comes to mind is tech behemoth Apple (AAPL) . With a 2.5% holding, Buffett could double his stake and still own a relatively small piece of the company -- while putting some of his cash holdings to good use.

The Shine on Apple

When I created a stock screening model based on the approach Buffett reportedly used to build his fortune (based on the book Buffettology, co-written by Mary Buffett), I applied the same conservative, stringent criteria to choose stocks that this legendary investor uses to evaluate businesses. Apple earns a perfect score under my model, as it satisfies the Buffett-inspired qualitative and the quantitative criteria. On the qualitative side:

  • Apple products enjoy enormous brand recognition.
  • Its products are widely used. In a February 2017 interview, Buffett said, "Apple strikes me as having quite a sticky product and enormously useful product that people would use."
  • The tech giant is surrounded by what Buffett calls a "competitive moat" -- an edge that is nearly impossible for another company to penetrate. The company has a loyal customer base, and the fact that many customers own more than one Apple product makes it even less likely that they would switch to a rival brand.
  • Buffett has openly praised CEO Tim Cook's management performance and his focus on keeping shareholders' best interests in mind.

Apple also satisfies the following quantitative tests:

  • Steady and predictable earnings growth: Predictable earnings per share that have been continually expanding over the last 10 years. Return-on-equity (ROE) of at least 15%, and return-on-total capital (ROTC, which includes debt) of at least 12%.
  • Conservative financing structure: Buffett likes to see that a company can pay off its long-term debt with earnings in under two years.
  • Positive operating cash flow.
  • Management that uses retained earningsto the shareholders' advantage (as measured by the change in earnings as a percentage of retained earnings over the most recent 10-year period), with the best-case scenario resting at or above 15%.

Buffett and Tech Stocks

Berkshire started buying shares of Apple in mid-2016 (owning nearly 60 million shares by year-end), but then upped its stake by more than double to the current level of 2.4%. When Buffett was asked about the decision, his answer was simple: "Because I like it." At this year's Berkshire Hathaway shareholder meeting, he expanded a bit on why:

  • Buffett considers Apple a consumer products company rather than a technology company.
  • He likes the company's brand and "ecosystem" whereby customers use several Apple devices and/or services.
  • The brand created consumer loyalty and low risk for switching products (due to the aforementioned ecosystem).
  • Apple products come with great aesthetics and ease of use.

Needless to say, Berkshire has made a bundle on its holdings. In a New York Times article published in September, Jeff Sommer wrote, "In the history of the markets since1926, Apple has generated more profit for investors than any other American company." While, in the past, the billionaire CEO of Berkshire has been openly wary of technology stocks, arguing that such companies and products would be difficult to understand, he clearly takes a different view of Apple. In a CNBC interview earlier this year, Buffett said in reference to the iPhone, "The degree to which people's lives center around the product is huge."

Right now, the quantitative model I run using Buffett's approach is estimating a 15% return on the stock over the next 10 years, using the average of two different stock price estimate methods. So as Buffett looks to bag the elephant and put some cash to work, the biggest and best prize might already be right underneath his nose.

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