Warren Buffett’s Apple Trade Is a Master Class in Investing

Warren Buffett, arguably the Greatest Investor Of All Time, surprised a lot of people recently when he announced that he's selling some of his investment in Apple. Yes, that Apple. The world's leading seller of dopamine dispensers. It's not a huge haircut, but the reason he's likely doing it now and the reason he bought Apple in the first place, is an investing lesson from the master. Incidentally, this is the last video of the season, and the reason I picked this subject is because it combines a lot of the things that I find most interesting, like investing, stocks, markets, and of course, Warren Buffett. It also gets deep in the data. And this is, after all, Do the Math. Alright let's dive in. Apple needs no introduction, obviously. But in case you're not super familiar with Warren Buffett — He's the longtime CEO of Berkshire Hathaway, a huge conglomerate that owns a bunch of businesses. It's a $900 billion company and the eighth most valuable business in the world. You can think of it as a giant mutual fund or ETF that holds a bunch of investments Buffett has collected over the years — like Apple, American Express, Coke, and a bunch of other great brands. There's so much to say about Buffett that he could fill a Ken Burns-esque marathon documentary, but the short story is that no one has ever managed as much money as Buffett for as long as he has, and with as much success. To understand why Buffett bought Apple in the first place, and why he likely sold some of it recently, it helps to know a little bit about Buffett's journey. And what that record shows is that since 1965, for nearly five astonishing decades, an investment in Berkshire returned 20% a year, more than twice the return of the S&P 500. That result is so unfathomable that it's hard to put it in perspective. But let me try. Close to 90% of professional stock pickers — I don't mean people playing around with stocks in their basement — I mean professional stock pickers, lose to the S&P 500 over ten years or longer. And of the few who win, most are lucky to eke out a percentage point or two over the S&P 500, managing a few billion dollars over a career of 5 to 10 years. Just to summarize, while managing a growing pile of money that's now close to $1 trillion, Buffett doubled the return of the S&P 500 over five decades. making him the GOAT. But Buffett didn't do it alone and he evolved as an investor along the way. A big part of that evolution was the influence of his longtime business partner, Charlie Munger, who passed away last November, a month short of his 100th birthday. People don’t seem to get that point. Do you have any idea why, Charlie? Warren, if people weren’t so often wrong we wouldn’t be so rich. In Berkshire's most recent annual letter, Buffett credits Munger as the architect and says that he merely carried out Munger's vision. That's a huge overstatement and typical Buffett modesty, which is another thing about Buffett: No one as great as he is has that much humility, especially when it comes to money. Still, it's true that Buffett would not be the same investor without Munger. When Buffett started out, he was a classic value investor, a strategy he learned from his teacher and mentor, Ben Graham. Quick side note: Ben Graham wrote the greatest investment book of all time called The Intelligent Investor, which I highly recommend. Okay, back to Buffett. He started out as a value investor, which is a strategy that buys companies that are cheap relative to some attribute, such as assets, earnings, sales, cash flows, or some combination of those things. For example, Apple trades at about $190-per-share and is expected to generate earnings-per-share of about $6.60 this year. So that gives it a price-to-earnings ratio of about 29. A value strategy might be to buy the cheapest 50 stocks in the S&P 500, which today would have an average price-to-earnings ratio of about nine, one-third of the price of Apple’s. When Graham pioneered value investing in the 1920s, he didn't have the data to prove that it worked. But we do now ... And what that data shows is that value investing has worked phenomenally, pretty much no matter how you did it. Here's one example: According to one data set that goes back to 1926, the cheapest 30% of US stocks by price-to-book value, meaning the companies with the lowest price relative to their assets have been the most expensive 30% by about three percentage points a year. The cheapest 30% also beat the most expensive 30%, close to 80% of the time over a rolling 10-year periods. So value investing works. Or at least it has worked for a long time. The thing about value investing, though, is that cheap companies are cheap for a reason. They're usually going through a tough time, like airlines during the Covid pandemic. Or their old businesses, like Detroit carmakers Ford and GM. Or they don't make a ton of money, like many US banks. That's no fun. Which is why they often sell for less than they're probably worth. That wasn’t how Charlie Munger rolled. Munger liked companies that dominate their industries and make tons of money. What we now call quality companies. And you know what? That strategy works, too. According to another data set that goes back to 1963, shares of the most profitable 30% of US companies beat the least profitable 30% by close to four percentage points a year. And the top 30% beat the bottom 30% more than 90% of the time over rolling 10-year periods. The thing about quality is that everyone wants to own companies that make tons of money, like Apple or Microsoft or Nvidia, so they're not cheap. But if you could blend Buffett's value with Munger's quality, in their words, buy wonderful companies at fair prices, you'd have the Holy grail. And that's exactly what they tried to do. But it's a hard combination to find, here's what you're up against. The most expensive 50 companies in the S&P 500 have an average return on equity, which is a common measure of profitability, of 153%. Meanwhile, the cheapest 50 companies in the S&P 500 have an average return on equity of just 9%. In other words, you generally get what you pay for in the stock market. But not always. Every now and then, if you're super patient and disciplined and attuned, you might find that rare combination of value and quality. And that's what Buffett and Munger found in Apple when they started buying it in 2016. It traded at only 10x earnings, less than half the price-to-earnings ratio of the S&P 500 at the time. It also came with a return on equity of 43%, more than double that of the S&P 500. Talk about a wonderful company at a fair price. Apple is even more profitable now than it was then. But it's also a lot more expensive. Trading at nearly a 50% premium to the S&P 500. So now it's a wonderful company at an extravagant price, which is probably why Buffett is taking some chips off the table. Buffett likes to tell investors to own the broad market and forget about picking stocks, as do I. But that's not what he does. If you want to move closer to Buffett's strategy without the risk of individual stocks, you can buy a value find in the quality fund in equal parts. And there are bunch to choose from. If history is any guide, you'll beat the broad market most of the time, but you won't rack up numbers like Buffett’s. For that, you'll need a small and carefully crafted collection of individual stocks. That takes a ton of time and discipline. And even then, it's hard to do well, which is why I don't recommend it for most people. But if you're tempted to try, just be sure you're buying wonderful companies at a fair price.