At this point, the Berkshire-Apple talk is becoming old. I find it incredibly interesting though. It is very cool to see the greatest investor of all time execute. He is turning 90 and seems as sharp as ever.
We do not know much about how it all started. Berkshire is secretive. Specially on a current holding and Ted/Todd moves. So, not everything here is 100% accurate. But we can speculate, it can be fun.
Activity
In Q1 2016, Berkshire disclosed a new position of 10mm shares in Apple, worth at the time $1.0bn. I suspect Ted Weschler made the initial purchase, based on his comments on the Company. He gave an interview around the time arguing that Apple had elements of a subscription model. Also, other details of the thesis that were proven right a few years later.
In Q2 2016, he added around $100/share increasing the position to $1.5bn, or 15% of his portfolio. This is a significant investment, but at the time Berkshire followers did not pay close attention to it, given likelihood Buffett was not involved. Buffett for years had stayed away from technology, arguing it was outside his circle of competence.
We were all surprised in Q4 16 when Berkshire disclosed 42mm additional Apple shares, bought at roughly $130/share. At this moment, we all knew Buffett was behind the purchase. As is often the case, Buffett went in aggressively buying 72mm shares next quarter, around $150/share. Then he took a breather for next 3 quarters. In Q1 18 made his final big purchase with 74mm shares around $180/share. He kept buying smaller amounts until Q3 18, when he was done for good with the purchases.
Takeaways
Buying on the way up: Buffett started buying at $130/share but made large purchases at prices 30% higher. This is difficult for most people, and even harder if the stock moves up before one has started buying. Most investors have mistakenly thought they missed an opportunity as it moved slightly higher while doing the analysis. Then it becomes extremely painful as the stock goes on and on and on. We have all experienced it.
Concentration: Buffett is known for taking concentrated positions. He has often said that an investor does not need more than 3 positions in a portfolio. His famous punch card style is known by many but practiced by few. In the past, he has made companies like American Express, Coca-Cola, etc. large positions, often more than 30% of a portfolio. Apple is his latest example, as we now know. When Buffett finished buying in late 2018, it was close to 30% of the portfolio. Berkshire now has significant positions outside the securities portfolio, but still, it is a huge concentrated bet. Few funds nowadays take such bets, most are highly diversified.
Patience: According to Charlie Munger, once he asked a racetrack manager if there were any successful players (given how bad odds were). The manager told him, there were a few. Those few were of course knowledgeable, but a trait they shared was they seldom placed bets. Munger later said that he only knew a few investors who could beat the market, and they shared that trait. Buffett rarely makes new large investments. In the late 80s, he went 3 years doing zip. He then went on and placed +20% of the Portfolio in Coca-Cola and made a killing. In the current example, for years investors had been complaining (and still are, they also have a point) about the cash pile. Then he found his elephant in the public markets, in plain sight, and took the opportunity.
Discipline: At times like these, in which quality businesses tend to trade at rich valuations, some investors feel the need to pay up. When Berkshire started buying Apple in 2016, it traded at less than 10x free cash flow. Buffett bought most of the position between 12–15x. He got the opportunity to invest in one of the best businesses of the world at very low multiples. Carl Icahn called Apple a “no brainah” given how statistically cheap it was.
Mr. Market, you are wrong!
Looking back, it is difficult to understand how such a high-quality business traded at what seemed like an undemanding valuation. Berkshire started buying Apple at $100/share in 2016 and bought all the way up to $180/share in 2018. Numbers, don`t lie. Apple was a cash flow machine, with a net cash balance of $150bn. Yet this well-known franchise traded as if it was dying.
At the time, from what I remember, there were many doubts surrounding Apple. For years, it traded at a large discount to the market even as most people knew the power of the products and brand. Mr. Market had doubts about the durability of the business as some thought the company would end up like Nokia or RIMM. Investors looked closely at the iPhone upgrade cycle, focusing on the popularity of each model. The market is highly competitive and there was/is the possibility that low-cost devices would end up killing Apple. Also, Google was the dominant software provider, and many thought they would end up dominating the space. In that case, developers would eventually leave the Apple ecosystem behind and without apps, basically worthless.
Given this backdrop, it is worthwhile to analyze what Buffett might have understood that the market was missing. After making his investment, Buffett has made some comments, so there is that.
Buffett: Apple, the best business in the world
In an interview after he finished buying, he mentioned Apple should not be thought of as a technology company but as a consumer products company. Apple has built a strong brand that people want to associate with.
He went on to say that those few inches are some of the most valuable real estate in the world. Eyeballs spend a large portion of the day looking at that screen, we all know it. Apple owns that real estate and they, deservedly so, charge for it. We all know about the controversial 30% Appstore fee, but they also charge Google close to $10bn a year to be the default search engine.
Another insightful comment was that the client base had great demographics. Consumers were young and they would probably keep being customers for a long time. Also, there was room for penetration in developing countries as middle class grew (and they would eventually afford Apple products). This is similar to the analysis of Coca-Cola back in the day, when he calculated the servings per country and how high these could eventually go in underpenetrated markets.
Finally, some comments about pricing power. Buffett mentioned that the iPhone was underpriced given the utility of the product. Customers spent hours a day in a device that meant the world to each of those users. A lot of people would pay a lot to remain iPhone customers. I must say, the product seems a bit pricey for most people, but who knows. It might go higher (as a customer, hope not!).
High Quality at a Discount: Cinch
Maybe Apple was just too cheap fur such a high-quality business. This is the great thing about the market. We can ignore it, but a few times in our career we might get opportunities to invest in great companies at low valuations. This rarely happens in a private transaction, as the other side knows a lot about the business and is unlikely to sell at large discounts.
I like this quote from Glenn Greenberg. It is simplistic but seems to work. Problem is nowadays we don`t see these opportunities in the markets. Things can change quickly though, as we saw in march.
“If you could buy a decent — not great, but decent — quality business with a 10% free cash flow yield, my experience is that you would not lose money. A decent business is going to grow — maybe not really fast, but if you can start out with a 10% free cash flow yield and it is going to grow at some modest rate, 3–4% you are going to end up with a pretty decent investment — a theoretical 13–14% rate of return.”
Since the initial Berkshire investment in 2016, Apple has returned more than 50% of the purchase price in buybacks and dividends. This is a capital return of more than 10% a year. Pretty good.
Holding on
One of the things that successful investors share is they let winners run. Buffett says that finding great companies at reasonable prices is so difficult that once he gets to invest in one, and partner with quality management, he would like to hold forever.
It is very difficult to hold onto winners as they, at times, become pricey. In the case of Apple, I am pretty sure I would have sold (mistakenly) long ago. That is one reason Buffett is so good at this. He lets winners run and run and run. In the last letter to shareholders, he said he had made many mistakes, but the beauty of Berkshire is that those missteps become small and then irrelevant overtime. The winners are the ones that move the needle as he keeps them and they grow.
In the case of Apple, Carl Icahn was a moving force behind the capital return move. He did shareholders a big favor. Unfortunately, he did not enjoy most of the gains. As most of us often do, he sold way too early. Icahn sold his 1% position in Apple in 2016, the stock went on to +4x over next 5 years.
This happens to most of us. Over time I have owned Apple, Moody`s, Google, Heico, etc but my gains from these names have been minimal compared to what they would have been by just letting them run. I probably used proceeds from sales (after a brief jump) to buy some losers. We live and we learn.
Buffett is the master of buy and hold.
Going Forward
Apple is now close to 50% of the equities portfolio at Berkshire. Buffett has mentioned he considers it the third largest business after Insurance and BNSF. This might mean he views it as a forever holding.
So far, the unrealized gain is close to $80bn. Going forward, who knows what will happen. I am confident that returns won`t be spectacular given the $2tn valuation.
Apple will probably continue returning cash to its shareholders via buybacks and dividends. They have reduced share count by more than 20% over the past 5 years. The company generates more than $60bn a year in free cash flow and has a mountain of cash.
As a Berkshire shareholder, I hope our 6% ownership of Apple keeps growing and that the cash flow gusher finds a way to Omaha.
