Besides having wholly owned operating businesses, Berkshire Hathaway holds a massive $374 billion public-equities portfolio. In total, there are nearly four dozen stocks in which the conglomerate has a stake.
You'll quickly realize, however, that Apple (AAPL -0.69%) makes up 41% of the entire portfolio. That position has been driven by impressive share-price gains. Warren Buffett first purchased this "Magnificent Seven" stock in the first quarter of 2016. Since the start of that year to today, Apple is up a jaw-dropping 542%.
The average investor can learn a lot by figuring out the factors that prompted the Oracle of Omaha to bet on Apple almost a decade ago.
Apple was a once-in-a-generation investment opportunity
Around the time Buffett first scooped up Apple stock, investors were concerned about weaker demand for the newest iPhone. In fact, in surprising fashion, the business posted an 8% revenue drop in fiscal 2016 after sales jumped 28% the previous year.
The market wasn't pleased, as investors were overly focused on near-term results instead of the company's long-term trajectory. I'm sure the thinking was there wasn't much more growth potential because Apple was generating more than $200 billion in annual revenue.
Consequently, Berkshire was able to buy shares at a price-to-earnings (P/E) ratio of around 11. That valuation looks like an absolute steal in hindsight.
That's because this was still one of the world's best enterprises in 2016. Apple benefited from a strong brand presence, not just in the U.S., but also on a global stage. Berkshire's top holdings consist of companies that have powerful name recognition, like Coca-Cola and American Express. Perhaps no business has a more valuable brand than Apple.
Buffett also certainly appreciated the company's proven pricing power. Apple sells the most popular hardware devices on the planet, a statement that has been true for a long time. Consumers have shown a willingness to pay ever-increasing prices for these gadgets that they can't live without.
Unlike many of the speculative, growth-focused companies investors seem to be enamored with today, Apple was in a fantastic financial position when Buffett first purchased the stock. In fiscal 2016, Apple reported an operating margin of 28% and net income of $46 billion. Apple was also returning lots of capital to shareholders with dividends and buybacks.
Apple's forward returns aren't going to resemble the past
Now that investors have an idea of what Buffett first saw in Apple, a bet that turned out to be incredibly lucrative, let's look at the current situation. It's hard to believe, but this is an even more dominant enterprise today, with much higher revenue and earnings potential.
But investors shouldn't expect forward returns to come close to matching historical gains. That's because Apple shares trade at a P/E ratio of 26.3 today -- about 150% more than what Buffett paid in early 2016. The market fully recognizes and appreciates that Apple is one of the world's elite companies.
It would be totally fine to pay that above-market valuation if the business was staring at a major growth opportunity. However, that's not the case. As much success as the iPhone has had, it is now in a mature stage of its product lifecycle. Consequently, consumers don't feel the need to upgrade to the newest model as often as they did before.
Wall Street analysts think Apple will be able to grow revenue and earnings per share at compound annual rates of 4% and 8%, respectively, over the next three fiscal years. That forecast doesn't come close to justifying paying the current valuation. As a result, it's best to avoid Apple stock unless there's a sizable pullback.
