Berkshire Hathaway (BRK.A -0.76%) (BRK.B -0.39%) is a massive conglomerate that owns a sizable public equities portfolio. Average investors are constantly watching how these holdings change to see if they can find any solid buying opportunities.
Among the numerous holdings that the Warren Buffett business owns, Apple (AAPL -0.33%) is by far the biggest, representing a whopping 47% of the overall portfolio. The Oracle of Omaha first purchased shares in the tech enterprise early in 2016.
Let's try to understand what characteristics first attracted Buffett to Apple stock. Then we can assess if this company makes for a good investment right now.
Extremely positive attributes
During the first three months of 2016, when Berkshire initiated its stake in Apple, the stock traded at an average price-to-earnings (P/E) ratio of 10.6. In hindsight, that was a fantastic entry valuation to pay. This isn't surprising, as one of Buffett's key criteria when investing is to ensure there's a margin of safety present.
In the five-year period that ended Dec. 31, 2015, Apple shares were up 128%, a gain that trounced the Nasdaq Composite index. So, it's still surprising that even with this outperformance, the stock was dirt cheap.
It makes sense why the valuation matters. All else equal, a lower P/E multiple can translate to higher returns. That's because the market is underpricing a stock for whatever reason. Maybe investors have just become pessimistic about its prospects, leading to greater upside should things work out.
Besides the valuation, Buffett was surely drawn to Apple's incredibly powerful brand, which makes up its economic moat. Presenting the brand with a premium status in the marketplace has resulted in strong demand from consumers, who are willing to pay up for Apple's products. This means there's also pricing power present. Buffett has said that pricing power is the most important trait he wants to see in the companies he's looking to buy.
Selling beautifully designed hardware, which pairs seamlessly with its software and services, puts Apple in a truly advantageous position because this combination creates a sticky ecosystem. Once customers commit to that Apple ecosystem, it's unlikely they will switch to competitors.
NASDAQ: AAPL
Key Data Points
Finally, Buffett was certainly compelled by Apple's outstanding financial situation. In fiscal 2015, Apple generated a gross margin of 40.1%, an operating margin of 30.5%, and free cash flow of $69.8 billion. The balance sheet was superb at that time as well, with cash, cash equivalents, and marketable securities of $205.7 billion, compared to long-term debt of $53.5 billion.
Combining a cheap valuation with strong financials, a powerful consumer brand, and pricing power, it's clear why Apple became a top holding for Berkshire and Buffett. From the start of 2016 to Oct. 23 of this year, shares of the tech giant have soared 557%. That's a hugely successful investment.
From today's perspective
Looking at Apple today is a different story, though. Thanks to the stock's impressive rate of appreciation, it is no longer attractive from a valuation perspective. The current P/E ratio is 29.1. That's substantially more expensive than its trailing-10-year average.
So, would Buffett buy at this valuation? I don't think so. He likely still owns the stock because of the sizable dividend income Apple produces for Berkshire.
For prospective investors who are thinking about buying Apple, there's a high probability that returns going forward won't resemble the past. To be fair, this is still a dominant enterprise. But that steep valuation is being applied to a company that's a lot more mature these days.
It takes a lot of growth to move the financial needle for Apple, which is tough given that its flagship product, the iPhone, might be hitting a saturation point in its key markets, like the U.S.
While I don't think Apple looks like a smart buy right now, investors can still look to Buffett's decision as a guide for what to look for in potential ideas.
