In April 2016, billionaire Carl Icahn announced that he had sold his shares in Apple due to his concern about the company’s business in China. Then not long after in May 2016, Warren Buffet’s Berkshire Hathaway bought Apple’s shares valued at around $1bn. Buffet’s reputation as an astute investor may have surprised the market especially considering Apple’s falling quarterly earnings. In fact, there is no guarantee that Buffet’s investment in Apple will pay off. For instance, Buffet had made a multi-billion dollar acquisition in IBM shares in early 2011, and then added some more early this year. However, IBM’s stock price is now trading for less than the price he acquired them for.
Similarly, Buffet acquired Apple stocks when the company’s price-to-earnings (P/E) ratio is at a very low 10-ish region. Some analysts say the ridiculously low P/E ratio is the reason for Buffet’s decision to buy Apple shares. Or is Buffet looking at Apple from a completely different angle?Embed from Getty Images
Here are two possible factors to consider.
Earnings growth. Between 2004 and 2012, Apple posted tremendous earnings growth – 310%, 246%, 60%, 73%, 73%, 34%, 67%, 83% and 60%. This was mainly due to the introductions of the iPod (2002), iPhone (2007) and the iPad (2010). It was also during this period that the company’s stock price went from around $12 per share to over $85 per share, and then continued to $130 by mid-2015. After that, it fell sharply to around $98 at the end of May 2016. In contrast, Apple’s price-earnings ratio during the same period showed a declining trend – 34.4%, 33.8%, 39%, 21.2%, 20.5%, 18.7%, 13.8%, 15.1%, 12%, 15.7%, 15.5%, and in May 2016, 10.96%. This shows that, despite a huge jump, the company’s actual stock price during these period could not keep up with its actual earnings, especially up until mid-2015. Since mid-2015 however, Apple’s earnings for the last two quarters had peaked and declined – revenue by 33.37% and net income by 42.73%. The market factored this in and the result was an expectedly sharp decline in Apple’s stock price from its mid-2015 peak. The consequent sharp fall in Apple’s P/E ratio is really a reflection of the market expectation of the company’s future earnings potential. It is therefore hard to reverse the company’s downward price trend simply by creating a sudden capital injection such as that by Warren Buffet.
Shareholders’ value. Yet despite the company’s declining earnings in the last two quarters, Apple’s shareholders’ equity value shows resilience and surprisingly growth – from $123.33bn (Q1-2015), to $129.01bn (Q2-2015), $125.68bn (Q3-2015), $119.36bn (Q4-2015), $128bn (Q1-2016), and $130bn (Q2-2016). Although earnings performance plays an essential part in this, maintaining shareholder’s equity value is more to do with a company’s clever management of its current and fixed assets, and its short and long-term liabilities. Nonetheless, this may well suit Buffet’s ideal company for long-term growth in its shareholding value, and Apple’s management clearly demonstrate that capability despite challenging times. “When we own portions of outstanding businesses with outstanding managements, our favorite holding period is forever.” (Warren Buffett, 1988).