The average investor can improve his or her potential for returns by following successful investment managers. And there's perhaps no one better to look to than the great Warren Buffett.
The company that the Oracle of Omaha heads, Berkshire Hathaway, has a massive equity portfolio worth $370 billion. Among the numerous holdings, it's easy to notice that Apple (AAPL -0.35%) currently represents a whopping 48% of the total.
Let's try to figure out the reasons why Buffett first bought shares in the tech giant, and then assess whether Apple is a smart stock to buy right now.
Apple was a no-brainer investment for Buffett
Berkshire first added Apple to the portfolio during the first quarter of 2016, when the company's market cap was only about $550 billion. From the start of that year to Dec. 28 of this year, shares skyrocketed 638%, a gain that crushes the S&P 500. This incredibly successful investment looks like a no-brainer decision in hindsight.
While Buffett has long been notorious for staying away from tech stocks, I think he realized that Apple was so much more than that classification. First and foremost, this business had one of the most powerful brands in the world. And this supported Apple's economic moat, something Buffett prioritizes in the companies he owns.
Look through the Berkshire portfolio, and you'll see strong brands like American Express and Coca-Cola at the top of the list. Apple fits in here.
Apple's brand allows it to charge premium pricing for its products and services. New iPhones, which are released every year, are some of the most expensive consumer hardware items in the world, yet they are usually met with robust demand.
Buffett also appreciates companies that are financially sound. In fiscal 2015, Apple posted an operating margin of 30%. And at that time, the business had over $200 billion of cash, cash equivalents, and marketable securities on the balance sheet. Owning a profitable and cash-rich enterprise like Apple substantially reduces financial risk.
Perhaps the key reason that enticed Buffett to push the buy button was Apple's low valuation. During the first three months of 2016, the stock's price-to-earnings (P/E) ratio averaged just 10.6. Looking back, this was a ridiculously cheap metric to pay for such a wonderful business, and it meant the return upside was massive.
Should investors buy Apple stock right now?
Apple clearly worked out for Buffett and Berkshire Hathaway over the past eight or so years. But is this a smart stock to buy now?
It's obvious that Apple is facing more limited growth prospects these days. In the most recent fiscal year, for example, the company's revenue actually declined by 2.8%. This was at a time when big tech peers are still registering healthy growth.
To be fair, Apple generated total sales of $383 billion in fiscal 2023. Naturally, it's extremely difficult to move the needle with such a large revenue base. And by depending so much on a single product, the iPhone, the business is in a position where it has to come up with a game-changing, new version to drive gains going forward. This will be tough.
The stock's current valuation is also a major headwind. Shares are trading hands at a P/E of about 31 right now. That's well above the trailing-10-year average, and it's 3 times what Buffett initially paid.
Before buying a stock, investors have to ask where the returns will come from going forward. In Apple's case, the current setup doesn't provide a high probability of outperforming the overall market over the next five years, in my opinion. Therefore, unless the valuation drops significantly, it's best to pass up on buying Apple shares.
