Apple is Buffett's biggest stock, but his moat thesis faces questions

Berkshire HathawayWarren Buffett was still using a foldable phone as of late 2020, four years after his investment giant began amassing a huge stake in the company that makes iPhones.

“I don't understand the telephone at all, but I understand consumer behavior,” Buffett said last year at Berkshire's annual shareholders meeting in Omaha, Nebraska.

He has emerged in recent years as one of apples Senior missionaries.

At the end of 2023, Berkshire owned about 6% of Apple, a stake worth $174 billion at the time, or about 40% of the conglomerate's total value. That's about four times larger than Berkshire's second-largest public stock, American bankmaking the company the No. 2 shareholder in Apple, behind only Vanguard.

As Berkshire investors and fans of the 93-year-old Buffett flock to Omaha this weekend for its 2024 annual meeting, Apple is likely to be a hot topic of discussion. The tech giant on Thursday reported a 10% year-over-year decline in iPhone sales, resulting in a 4% decline in overall revenue. But the stock had its best day since late 2022 on Friday due in large part to a $110 billion stock buyback plan and increased margins resulting from growth in its services business.

The bet on Apple and CEO Tim Cook has paid off well for Buffett, who said in 2022 that Berkshire's stake in Apple would cost just $31 billion. His company's investments have increased by approximately 620% since the beginning of 2016.

Although he describes himself as a “satisfier,” Buffett has long had a coherent, non-technical thesis about loving Apple. He saw how loyal Apple users were to their devices, and viewed the iPhone as an exceptional product that could keep his customers spending within the Apple ecosystem. He calls it the Trench, which is one of his favorite words to describe his favorite works.

“Apple has a position with consumers that they pay $1,500 or whatever for a phone, and these same people pay $35,000 for a second car,” Buffett said at a meeting last year. “And if they have to give up their second car or give up their iPhone, they will give up their second car!”

The data is in his favour. According to a study by Consumer Intelligence Research Partners, Apple benefits from 94% customer loyalty, which means nine out of 10 current iPhone owners in the US choose another iPhone when purchasing a new device.

Buffett also praised Apple's ability to return billions of dollars to shareholders annually through stock buybacks and dividends, a capital allocation strategy for which the billionaire investor may be credited. When the Apple CEO was asked in a 2016 interview with The Washington Post who he turns to for advice at pivotal moments, Cook offered a story about his relationship with Buffett.

“When I was discussing (the question of) what should we do when returning cash to shareholders, I thought who could give us great advice here? Who wouldn't have a bias?” Cook said. “So I called Warren Buffett. I thought he was the natural guy.”

Apple has shown its appreciation for the Oracle of Omaha in other ways.

In 2019, the company published an original iPhone game called “Warren Buffett's Paper Wizard” in which a paperboy rides a bike from Omaha to Apple's hometown of Cupertino, California.

But with Apple's turnover declining in five of the past six quarters and with the company forecasting low-single-digit growth in the current quarter, Buffett may face questions this weekend at a shareholder meeting about whether he still sees the same strength in the company. ditch, especially with regulatory pressures accumulating around giant tech companies.

Buffett reduced his stake in Apple late last year, albeit by only 1%. Even after Friday's rise, the stock is down 3.8% in 2024, while the S&P 500 is up 7.5%.

Berkshire's initial foray into Apple in 2016 was not Buffett's idea. Instead, the investment was led by Ted Weschler, one of his top deputies, and was seen as passing the torch to the next generation of investment managers at Berkshire.

But the next year, Berkshire started buying more Apple shares, and Buffett started talking about it. He said he liked the stock and the company's “sticky” product, even though he didn't use it.

In 2018, he said Apple users were “very, very closed off, at least psychologically and mentally” to the product and ecosystem.

“Apple has an exceptional consumer franchise,” he said.

At last year's annual meeting, when asked how Berkshire could make a case for making Apple a big part of its overall portfolio, Buffett said: “It's a better company than any we've had.” He also praised Cook as one of the “best managers in the world”.

The number Apple likes to use to tout the health of its business, despite declining revenues, is “2.2 billion.” That's how many devices the company says are currently in use and indicates the huge customer base available as Apple rolls out new subscription services.

“Once customers enter the ecosystem, they don't leave,” said Dan I, chief investment officer at Fort Pitt Capital Group, which owns Apple shares. “So it's not a technology speculation game.” “It's more like an annuity and I think that's what Warren Buffett sees as well.”

In addition to declining revenues, Apple faces new challenges from regulations and weak foreign markets, as well as… Microsoft And Google Advances in the field of artificial intelligence. For regulators, the concern surrounds the moat that Buffett finds so attractive, and whether it gives the company monopoly control in the smartphone market.

The US government claimed in March that Apple designs its business to keep customers locked out. The Justice Department's lawsuit alleged that products like Apple Card, Apple Arcade game subscription, iMessage and Apple Watch work best or only with the iPhone, creating illegal barriers. to compete and make it difficult for consumers to switch when it's time to upgrade.

However, the lawsuit is expected to take years, pushing any potential penalties back to Apple and its products in the future. Meanwhile, there is no sign that the iPhone is becoming less relevant as new devices such as virtual reality headsets have only found niche audiences, while consumer AI products have failed to take off.

Buffett has not publicly expressed his view on the regulatory hurdles Apple faces, and this will be the first opportunity for investors to ask him about the issue since the Justice Department lawsuit. But Buffett knows a little something about regulation – the two markets in which he is most active are railroads and insurance.

In a note to clients earlier this month, Bernstein analyst Tony Sacconaghi did not delve into regulatory concerns, but stated that he did not believe the Justice Department's lawsuit would “seriously threaten” the strength of Apple's ecosystem. He also said that following Buffett's lead in moving in and out of Apple is a solid money-making strategy.

“Despite his reputation as a long-term buy-and-hold investor, Warren Buffett has been remarkably disciplined in adding to his position in Apple when it is relatively cheap and reducing when it is relatively expensive,” Sacconaghi wrote. He encouraged investors to “be like Buffett.”

Buffett will likely be pleased with Apple's announcement this week about an expanded buyback program. It's a practice he has long loved.

“When I buy Apple, I know Apple is going to buy back a lot of stock,” he said in 2018.

He likes to notice how buybacks result in a larger stake in the company without buying more shares.

“Repo accounts are slow going, but they can be powerful over time,” Buffett said in 2021.

Apple also increased its profits by 4%, and indicated that it would continue to raise them annually.

Buffett was enthusiastic about the tech giant's capital return strategy at the conglomerate's annual meeting last year, noting that it helped Berkshire own a bigger piece of the pie. Unlike insurance company Geico and homebuilder Clayton Homes, which his company wholly owns, Berkshire can continue to increase its stake in Apple, a fact he reminded investors of at the meeting.

“The good thing about Apple is we can go up,” Buffett said.