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.