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Does Warren Buffett Know Something Wall Street Doesn't? The Billionaire Is Selling an Ultra-Popular Artificial Intelligence (AI) Stock.
In 2016, Berkshire Hathaway stunned Wall Street when it purchased a position in the ultra-popular consumer electronics company Apple(NASDAQ: AAPL). CEO Warren Buffett, who reportedly controls the vast majority of the company's investment portfolio, had previously avoided technology stocks because they admittedly fell outside his circle of competence.
Wall Street was even more surprised when Apple eventually became Berkshire's largest holding, a position it still occupies today. But Buffett's asset allocation decision was brilliant in hindsight. Including dividend payments, Apple stock has returned 860% since his company first bought shares.
However, Berkshire sold 389 million shares of Apple stock in the June quarter, reducing its position by nearly 50%. That happened despite Buffett saying last year that Apple was a "better business" than any other in Berkshire's portfolio. Additionally, his company sold shares ahead of the launch of Apple Intelligence, which could be a major catalyst.
Finally, Apple has a consensus rating of buy among Wall Street analysts, and the median 12-month target of $250 per share implies about 8% upside from the current share price of $231. All those facts lead to one conclusion: Buffett must know (or suspect) something that Wall Street does not.
Apple has a durable competitive advantage in its brand authority and pricing power
Warren Buffett has lauded Apple for its brilliant leadership in CEO Tim Cook, and he has praised the company for consistently returning capital to shareholders through dividends and buybacks. But what Buffett admires most about Apple is its pricing power, so much so that he once said the iPhone "may be the greatest product of all time."
Apple uses its deep engineering expertise to design custom chips, pairing that cutting-edge hardware with proprietary software and services to create a differentiated user experience. Unlike the open-source Android operating system, iOS and macOS are closed-source operating systems that cannot be co-opted by third-party equipment manufacturers.
The end result is that while Android devices are far more common, Apple products command much higher prices. Consumers are willing to pay a premium for the Apple experience. For example, Counterpoint Research shows that the average iPhone currently sells for three times more than the average Samsung (Android) phone.
That pricing power is a product of brand authority, which itself is a key competitive advantage that has helped Apple secure a strong presence in several consumer electronics categories. The company leads the market in smartphone sales and ranks second in smartphone shipments, behind Samsung. Apple also ranks first in smartwatch and tablet shipments and fourth in PC (personal computer) shipments.
Beyond hardware sales, Apple monetizes its installed base (2.2 billion-plus active devices) with services like App Store downloads and advertising, iCloud storage, subscriptions like Apple TV+, and financial services like Apple Pay. The company has a strong presence in several relevant markets. It runs the largest mobile app store as measured by sales, and Apple Pay is the most popular in-store mobile wallet among U.S. consumers.
Buffett trimmed Berkshire's stake in Apple ahead of a major catalyst
Apple is expected to release iOS 18.1 on Oct. 28. The highly anticipated software update will bring a suite of artificial intelligence (AI) features, called Apple Intelligence, to iPhone 16 and some iPhone 15 models. Certain industry observers expect Apple Intelligence to drive a historic iPhone upgrade cycle while laying the groundwork for paid AI services in the future.
Indeed, Wedbush analyst Dan Ives has said Apple Intelligence is a "clear path to a multiyear product upgrade cycle." Morgan Stanley analysts have arrived at the same conclusion, calling Apple Intelligence "the closest possible offering to a true smart virtual assistant in the market today." That raises questions about why Buffett sold Apple stock ahead of what could be a major catalyst.
Buffett attributed the decision to his belief that the government would raise the corporate tax rate in the future to get a handle on widening fiscal deficits. In that scenario, selling Apple stock in the present allowed Berkshire to keep a greater portion of the capital gains than it otherwise would have if the tax rate were higher. While that explanation is entirely sensible, there must be more to the story.
A higher corporate tax rate would hit any stocks sold at a profit, but Buffett didn't sell down other long-standing positions, like American Express, Coca-Cola, or Visa, and he trimmed Chevron much less than Apple. So, what does he know (or suspect) about Apple that Wall Street is overlooking?
Warren Buffett knows valuation always matters
Apple is a wonderful company with enviable brand authority. It has a strong presence in several consumer electronics verticals, and its push into AI could be a major catalyst for the business. But Warren Buffett knows valuation always matters, and Wall Street seems to be overlooking that fact where Apple is concerned.
Analysts estimate Apple's earnings will increase at 9.4% annually over the next three years. That makes the current valuation of 35.2 times earnings look expensive. Those figures give a price/earnings-to-growth (PEG) ratio of 3.7, a premium to the three-year average of 2.6. For context, PEG ratios below 1 are considered cheap, while ratios between 1 and 2 are usually considered reasonable. But a PEG ratio approaching 4 is almost certainly unsustainable.
Apple will announce results for the fourth quarter of fiscal 2024 on Oct. 31. The stock could move higher following the report if management provides upbeat commentary. Regardless, unless earnings increase much faster than forecasted over the next few years, I think Apple stock is headed for a correction at some point.
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American Express is an advertising partner of The Ascent, a Motley Fool company. Trevor Jennewine has positions in Visa. The Motley Fool has positions in and recommends Apple, Berkshire Hathaway, Chevron, and Visa. The Motley Fool has a disclosure policy.
