Warren Buffett's company, Berkshire Hathaway, bought its first shares of Apple (AAPL 1.27%) in Q1 2016. The company continued adding to its position through 2018. After selling some of its shares through 2020, Berkshire reignited a buying spree of its favorite stock in 2022.
At the end of Q2 2022, Berkshire owned 895 million Apple shares, making up nearly 43% of the company's stock portfolio. Alternatively, the stake represents about 22.5% of Berkshire's market cap and about 5.6% of all outstanding Apple shares. The stake makes Berkshire the third-largest shareholder behind index giants Vanguard and BlackRock.
Regarding Apple, Buffett has remarked that it's probably the best business he knows of in the world and that the iPhone is a "sticky" product that keeps people within the company's ecosystem. Those comments speak to Buffett's voracious appetite for Apple shares, but what does he mean by "sticky"?
A sticky product
The iPhone's history of fanciful design, advanced cameras, and innovative features has helped the smartphone attract a loyal following. The iPhone commands roughly half of the U.S. smartphone market and 17% of the global market. Making it cool is one way to design a sticky product, but there is more to the story.
Image source: Getty Images.
iPhone users will gladly tell you about the services included in the smartphone's ecosystem. For a small fee, users can store pictures and other data on an iCloud account, download songs from Apple Music, and set up touchless payments with Apple Pay. Buffett may think the iPhone is sticky in part because he believes that once a customer builds a lifetime of selfies and family photos, they're more likely to buy another iPhone when the time comes. Otherwise, accessing pictures becomes a cumbersome process if customers switch smartphones.
Likewise, iPhone customers who have taken the time to connect their bank accounts and cards to Apple Pay will have to reconnect each one if they switch to a competing smartphone. Apple's ecosystem creates a flywheel effect whereby the iPhone's popularity begets services, and those services beget the next iPhone purchase. As Apple collects new iPhone customers over time, its sticky flywheel ecosystem strengthens.
Here are some numbers that back Buffett's comments. The company launched Apple in 2015 with 6.5 million paid subscribers and reported 78 million in June 2021, implying annual compounded growth of greater than 50%. JPMorgan forecasts that Apple Music will reach 110 million paid subs by 2025. Meanwhile, Apple Pay dominates mobile wallet payments, representing 92% of mobile wallet payments in 2020, when the COVD-19 pandemic opened the floodgates for contactless payments, which are expected to grow by 29% annually through 2028.
The iPhone's compelling combination of untamed popularity and entrenching ecosystem was demonstrated in Q2 2022 smartphone industry analysis. It showed that sky-high inflation and macroeconomic uncertainty reduced year-over-year smartphone shipments by 8.7%, which was short of estimates. Bucking the trend, iPhone shipments grew .5% in the quarter. The first quarter was even more eye-opening. Global shipments fell 11%, but iPhone shipments increased 8%.
Should you buy Apple right now?
Though Buffett has touted the stickiness of Apple's products, the economics of Apple's services segment is staggering. For instance, due to its captive audience of loyal iPhone users, Apple can push Apple Pay, Apple Music, iCloud storage, and other services for virtually no cost. On top of that, there is very little ongoing cost to adding new service customers. Therefore, each new dollar of revenue increases margin.
In 2017, when Apple first disclosed financial results for its services segment, it generated $32.7 billion in revenue and a gross margin of $17.9 billion. By 2021, services revenue had roughly doubled to $68.4 billion, and gross margin grew 2.6 times to $47.7 billion. The implication for investors is that as Apple's services business grows, the company generates more cash, a trait adored by Buffett.
The stock has fallen 13% this year and trades at a price-to-earnings ratio of 26 times, which has come down from highs above 40 in 2020.
AAPL PE Ratio data by YCharts
Interestingly, the multiples Buffett paid for Apple stock in the first two quarters of 2022 were visibly higher than when he started accumulating shares in 2016. But Apple is a company that increases in value over time. Value and growth investors alike should see the stock's tumble as an opportunity to emulate the world's most renowned investor by adding Apple to their portfolios.
