Analyzing companies from unusual perspectives can be a smart approach to identify high-quality investment ideas. Keeping this in mind, let's take a look at Apple (NASDAQ:AAPL) stock from the point of view of Warren Buffett's investment strategy in order to find out if the iPhone maker has what it takes to be considered a good candidate for Warren Buffett's portfolio.
Rock-solid competitive advantages
Competitive advantages are at the center of Warren Buffett's investing philosophy. In his own words:
The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage. The products or services that have wide, sustainable moats around them are the ones that deliver rewards to investors.
Brands can be one of the most powerful and effective sources of competitive advantages, and Apple comes second to none when it comes to brand value. Based on the Forbes Brand Ranking, Apple is in fact the most valuable brand on the planet, with a brand value of $124.2 billion.
That's almost double the value of Microsoft's (NASDAQ:MSFT) brand, which Forbes estimates to be worth nearly $63 billion. Google (NASDAQ:GOOG) (NASDAQ:GOOGL) comes in third position according to the publication, with a brand value $56.6 billion.
Interbrand ranks Apple as the most valuable brand in the world too, but it puts Google in the second position and Microsoft in fifth place.
There is always a degree of subjectivity when it comes to these kinds of rankings, but the fact remains that Apple owns a unique brand. Product differentiation, a reputation for quality and a notoriously loyal customer base offer huge advantages for investors in Apple stock.
Making tons of iCash flows
Warren Buffett appreciates companies with healthy balance sheets and generating abundant cash flows on a consistent basis. Apple is real cash machine, and the company's financial soundness is unquestionable.
Apple has more than $155 billion in cash and liquid assets on its balance sheet, and the business produced a massive $59.7 billion in operating cash flows during the twelve month period ending in September. Capital expenditures absorbed only $9.6 billion during the year, so Apple generated free cash flows for nearly $50.1 billion.
The company is distributing a big chunk of its free cash flows to investors via buybacks and dividends. Share repurchases amounted to $45 billion during the year, while dividends were in the area of $11.1 billion.
Buffett is willing to pay premium prices for superior companies, but he understands that the best opportunities arise when a high quality business is selling for a discounted valuation. In his 2008 letter to investors Buffett wrote:
Long ago, Ben Graham taught me that "Price is what you pay; value is what you get." Whether we're talking about socks or stocks, I like buying quality merchandise when it is marked down.
Apple trades at a price to earnings ratio of 17.8, a small discount versus an average price to earnings ratio of 18.7 for companies in the S&P 500 Index according to data calculated by Morningstar. On a forward-looking basis, Apple looks even cheaper, with a forward price to earnings ratio of 14.7 versus 18 for the broad market index.
Considering Apple's fundamental quality and financial strength, the current entry price allows for material upside potential.
The innovation problem
On the other hand, Apple operates in a very dynamic and always changing environment. Innovation and disruption are crucial factors to watch, the winner of today can easily be the loser of tomorrow, and this means investors need to closely monitor industry trends to make sure they are positioned accordingly.
Buffett prefers stable and predictable businesses over innovative growth companies, and this could be one of the main drawbacks that Apple presents from the perspective of Warren Buffet's investment strategy. On the matter of change and innovation, Buffett once said:
Our approach is very much profiting from lack of change rather than from change. With Wrigley chewing gum, it's the lack of change that appeals to me. I don't think it is going to be hurt by the Internet. That's the kind of business I like.
Buffett tends to stay away from companies in the tech sector but, leaving this consideration aside, Apple offers many of the characteristics that the Oracle of Omaha appreciates in a business. This says a lot about Apple stock and its potential for profitable returns over the long term.
Andrés Cardenal owns shares of Apple and Google (C shares). The Motley Fool recommends Apple, Google (A shares), and Google (C shares). The Motley Fool owns shares of Apple, Google (A shares), Google (C shares), and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.