May 3, 2024
By Gregory Zuckerman
In 2016, Warren Buffett made perhaps the most surprising bet of his career. That year, Berkshire Hathaway, the company he runs, began buying up shares of Apple — the exact kind of stock Buffett and his longtime partner, Charlie Munger, had long avoided.
A few years earlier Buffett, in a conversation with executives of another firm, had suggested that Apple fit the profile of a stock one might short, rather than a company to buy, according to someone close to the matter. Buffett says he doesn’t recall the conversation and over the past 50 years, “I have never recommended any stock to be shorted and always advise people not to short stocks.”
In 2013, Munger told Reuters: “You could hardly think of another business that is more un-Berkshirelike than Apple.”
Yet working with protégés, Buffett soon transformed into an Apple bull in a remarkable about-face. After an initial purchase of nearly 10 million shares worth about $1 billion in 2016, Berkshire added to its holdings later that year and then stepped up its buying in 2017 and 2018, spending about $36 billion on the stock over those years. Berkshire later trimmed some of those holdings.
By the end of the third quarter of 2018, Berkshire’s Apple stake represented about a quarter of its entire investment portfolio. In dollar terms, it was twice as large an investment as Buffett had previously made.
The move has paid off, in a very big way. Today, Berkshire’s 5.9% stake in Apple is worth about $157 billion, even though Apple has fallen lately. Berkshire is sitting on about $120 billion in paper gains, likely the most money ever made by an investor or a firm from a single stock. Nothing in Buffett’s long career comes close. Apple stock represented nearly 50% of Berkshire’s stock portfolio at year-end.
Berkshire has scored an annualized return of more than 26% from Apple, including dividends, topping a gain of 12.9% for the S&P 500 during the same period, according to a calculation by Cheviot Value Management, a Los Angeles-area investment firm.
Buffett’s Apple home run is so big and unlikely that it deserves more acclaim than it receives, say some investors, who argue that it also provides important lessons.
“Warren’s ability to change his mind is what’s so extraordinary because that’s what most investors struggle with the most,” says Chris Davis, who helps lead the Davis Funds and is on Berkshire’s board of directors. “Most of us anchor ourselves in our past statements, but Apple is a powerful example of the importance of being open to change.”
Now, though, Apple is running into problems. The stock is down 10% this year, despite gains for other tech stocks and the overall market. The company faces antitrust challenges, a slowdown in sales in China and criticism for its lagging artificial-intelligence efforts.
As Buffett convenes Berkshire’s annual meeting this weekend and the 93-year-old increasingly speaks about passing the reins, a difficult question is emerging: What will his successors do with all those Apple shares? Berkshire trimmed some of its holding recently, but the stake remains enormous.
“Apple is riskier now because of its elevated valuation, how regulators are focused on its most profitable segment, and the company’s slowing growth rate,” says Darren Pollock, who runs Cheviot and is a longtime Berkshire shareholder. “At the very least, investors should have different expectations for Apple today than they had several years ago,” which could weigh on Berkshire’s performance.
For Berkshire, Apple was something of a team effort. In 2016, Ted Weschler, one of two managers hired a few years earlier to help run Berkshire’s portfolio, decided on a relatively small investment of about $1 billion in Apple, Munger told The Wall Street Journal in a September interview.
Around that time, Buffett presented Todd Combs, the other investment manager, with a challenge, according to a session with Combs at an investment forum several years ago. Buffett frequently welcomes Combs on Saturdays at Buffett’s Omaha, Neb., home, where they chat about markets and Berkshire’s portfolio, Combs said at the forum.
This time, Buffett asked Combs to identify a stock in the S&P 500 that met three criteria. The first: a reasonably cheap price/earnings multiple of no more than 15, based on the next 12 months’ projected earnings. The stock also had to be one the managers were at least 90% sure would enjoy higher earnings over the next five years. And they had to be at least 50% confident that the company’s earnings would grow by at least 7% annually for five years or longer.
Combs’s research pointed to Apple, the same stock Weschler had already purchased.
Buffett asked about the customer-retention rate of iPhone users. When he learned it was approximately 95%, he really became intrigued. By then, Buffett’s grandchildren had become “addicted” to their iPhones, Munger said in the interview. Buffett also was influenced by a story of a friend, Sandy Gottesman, who had been bereft after misplacing his iPhone.
“Warren could see how dominant the products were,” Munger said in the interview. Munger died last year.
At that point, Buffett still used a flip phone, as did Munger. Buffett only converted several years later, though he still doesn’t spend a lot of time on his iPhone, Munger said.
Considering the stock, though, Buffett began to see it as a consumer-goods company with enviable, latent pricing power, rather than as a tech or an electronic-device maker, according to people who have spoken to him. The loyalty consumers had for Apple products, especially the iPhone, suggested to Buffett that they would be willing to pay much more for upgraded versions of the phone in the years ahead, a sure way to boost profits.
Buffett soon began buying Apple in large quantities. It seemed he was late to catch on to the company’s strengths, though. Investors including David Tepper, Carl Icahn and David Einhorn had already sold the stock after scoring big gains, in Icahn’s case after he pushed the company to improve its operations. Apple traded for about 14 times its expected earnings, well above the 10 P/E ratio it had fallen to a few years earlier, suggesting it no longer was such a great bargain.
There were other reasons for Buffett and Munger to steer clear. Apple doesn’t own extensive real estate or other physical assets that can provide investors with a certain safety cushion, so it is riskier than some other Berkshire investments, Munger acknowledged to an outside investor. And Buffett and Munger had long avoided technology stocks, saying they didn’t fully understand the fast-changing industry. Berkshire’s foray into International Business Machines had led to embarrassing losses.
Nonetheless, Munger got on board, encouraging Buffett to buy Apple shares — and later needling him for not buying more.
“How did we come around? Damn slowly,” Munger said. “We should have bought more Apple.”
Apple shares made tremendous sense in other ways. Berkshire is so big that the universe of companies it can buy in sufficient quantities to affect its returns is limited. Apple, which had a market value of about $584 billion at the beginning of 2016, fell into that category.
“People don’t understand this about Warren: He’s a natural-born capitalist who doesn’t like small and distracting positions,” Munger said.
Now, some wonder if Apple will weigh on Berkshire. Mohnish Pabrai, who runs Pabrai Investment Funds and considers himself a Buffett disciple, says he has long-term concerns about Apple, noting that it is hard for dominant technology companies to retain their positions.
“In 10 or 15 years, we will not have this brick in our hands all the time,” he says.
On Thursday, Apple said revenue declined for the fifth time in the past six quarters, and it authorized $110 billion in stock buybacks, sending shares higher in after-hours trading.
Apple shares remain expensive compared with the overall market despite this year’s drop, trading at about 25 times its expected earnings over the next 12 months, adding to the position’s risk.
There is a compelling reason for Berkshire to hold on to its Apple shares, and it might be the key one Buffett isn’t selling: It likely would be hard for Berkshire to find better uses for all the cash that a sale would produce.
“We don’t need their cash to go to $350 billion by selling Apple,” Pabrai says, arguing that the stock will become a smaller percentage of Berkshire’s portfolio over time, as other holdings grow.