Warren Buffett is arguably the greatest capital allocator ever. His track record at the helm of Berkshire Hathaway proves this: The conglomerate’s shares have increased by 40,000% in the last 40 years.
Scouring Berkshire’s equities portfolio for potential investments might be a smart idea for the average investor. By doing so, you’ll quickly realize that about 49% of the massive $365 billion portfolio is invested in just one stock: Apple (NASDAQ: AAPL).
It’s worth looking at some of the reasons Buffett decided to buy this FAANG stock in the first place. Then, by considering the situation today, investors can decide if Apple still makes for a smart investment.
Almost a no-brainer investment
Berkshire Hathaway first purchased shares of Apple during the first quarter of 2016. Since Jan. 1 of that year to Dec. 12 of this year, the iPhone maker’s stock price has skyrocketed 639%. That easily outpaces the 190% rise of the Nasdaq Composite.
Looking back almost eight years, it’s not hard to understand why Buffett was attracted to Apple as an investment opportunity. I think there were three key reasons.
For starters, Buffett realized that Apple wasn’t just a typical tech business. Instead, it was one of the strongest consumer brands on the planet. And this supported Apple’s economic moat, while giving the company proven pricing power.
Next, Apple is an extremely sound enterprise financially. In fiscal 2015 (ended Sept. 26 of that year), the business posted a gross margin of 40.1%, an operating margin of 30%, and free cash flow of $70 billion. And at the end of that fiscal year, it had $206 billion in cash, cash equivalents, and marketable securities on the balance sheet.
Lastly, while Buffett does appreciate wonderful businesses, he will not overpay for them. Apple shares traded at an average price-to-earnings (P/E) multiple of 10.6. In hindsight, that is a ridiculously cheap valuation, especially for such a dominant company.
In 2016, Apple hit on all of the characteristics that Buffett usually looks for in a stock. It was almost a no-brainer investment decision for the Oracle of Omaha at the time.
Is Apple a smart stock to buy right now?
Clearly, Apple worked out as a fantastic investment. And based on the dollar value of gains, it might be the most financially lucrative bet that Buffett has ever made. Even this year, the stock has soared 50%, so there is strong momentum.
Investors who have been on the sidelines might be looking at Apple as a potential buying opportunity right now. After all, it’s still Berkshire’s largest position by far. However, I don’t believe this is a smart stock to buy.
Apple’s current valuation isn’t remotely as cheap as it was in early 2016. As of this writing, shares trade at a P/E of 31.8, triple the range that Buffett first purchased them at. All else equal, this introduces a major headwind for investors looking to produce solid returns, as the optimism is fully priced in.
And a valid argument can be made that Apple simply doesn’t have the growth opportunities today that it did in years past, thanks to its already massive size. In each of the last four fiscal quarters, sales declined on a year-over-year basis, a sign that this is a mature business nowadays. Paying such a steep valuation seems like a mistake.
The way things stand, Apple stock just doesn’t make for a smart investment.
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Almost Half of Warren Buffett-led Berkshire Hathaway’s $365 Billion Portfolio Is Invested in Only 1 Stock was originally published by The Motley Fool