There are very few parallels in Warren Buffett’s investing career that can match the amount of cash that he has put forward to buy an ownership stake in a publicly traded stock. With Berkshire’s American Express and Coca-Cola stake, valued at $15 billion and $18 billion respectively, Buffett only put a little over $1 billion into each–the economic value of the investments became enormous because because they compounded at a nice clip over the past three decades. Berkshire’s $11 billion investment in Wells Fargo, worth around $30 billion today, is the largest amount of initial capital dedicated to an investment out of any current Berkshire holding.
This Apple move completely dwarfs that. Buffett has sunk $30-$35 billion of Berkshire’s own cash reserves into shares of Apple stock now worth between $40-$45 billion. The $10 billion gain that Berkshire already makes it one of only nine Buffett investors that have gone on to create more than $7 billion in total gains.
When I look at Big Tech–Apple, Microsoft, Alphabet f/k/a Google, and (it’s getting there) Amazon–we are dealing with cash reserves that are unparalleled in human history.
In 20th century America, the average net profit margin was 8.5%. A company like Apple earns almost triple that rate with a net profit margin of 21.6% in an industry where it has proven capable of ramping up iPhone demand so quickly that it has gone from selling $24 billion worth of iProducts in 2008 to selling more than a quarter-trillion of the same today.
The cash pile sits at $285 billion, with $100 earmarked for share buybacks.
Apple’s share count has declined from 6.5 billion in 2012 to a shade over 5.0 billion today, meaning that shareholders have received an “automatic” 4.5% annual return in that their ownership of the company has increased by that amount each year since Apple began its capital return program. Combined with a 1.6% dividend, shareholders get a solid 6.1% annual return just by virtue of Apple’s financial engineering plans (and notably, the dividends only consume a quarter of the company’s overall profits).
I suspect Buffett, who is now collecting about $730 million per year in Apple dividends for Berkshire, is aware of the fact that he has acquired a cash stream that will easily grow at a high single digit rate, coupled with the possibility of a very high compounding rate for the retained earnings.
As a student of the investment markets, Buffett is no doubt aware of how Standard Oil was split into seven constituent parts, the largest of which was Exxon, which went on to use its $5-$10 billion in cash reserves in the 1950s and 1960s (equivalent to about $30-$40 billion in today’s money) to rebuild the ExxonMobil colossus that delivered 13% annual returns over the half-century stretch from 1968 through 2018. Exxon’s oil wells were a powerful economic engine–third in size to only AT&T and General Motors at the beginning of the measuring period–that used the surplus to make acquisitions to maintain its size while dedicating the rest of its surplus to dividends and share buybacks.
Arguably, Apple is in an even stronger position because it is sitting on $285 billion in current cash that dwarfs the inflation-adjusted $50 billion that Exxon had available when it went on a historical half-century tear.
It is also critical that Apple’s dividend payout ratio currently sits at 25% of annual profits. This mean that it is only sending out $12 billion to shareholders as cash while having $45-$50 billion in annual profits available. When it repurchases stock and reduces the share count by 4.5%, Apple could raise the dividend by 4.5% and still pay out the same amount of money in absolute dollars.
A lot of times, when a company turns to share buybacks, it comes at the expense of research and development (ahem, IBM). Although I mention the potential for acquisitions, Apple can do just fine for itself through internal product development as it spending $13 billion each year in research and development, the specifics of which are often secretive although, based on Apple’s habit of firing employees who disclose to media outlets details concerning the artificial reality headsets, we can hazard a guess as to where at least some of it is going.
The discernment of Warren Buffett is that he is not scared by size. People might look at a business that earns net profit of $50+ billion against revenues of a quarter-trillion and conclude that a theoretical max has been reached. I think Buffett studied 1960s Exxon for instruction, and then saw how Apple compares favorably against that benchmark–Apple has five times the cash, half the payout ratio, and sextupled the R&D budget that 1960s Exxon had.
Apple has more cash on hand than the gross domestic product of what Finland is going to produce this year. That is a staggering advantage that buys Apple a head seat at the tech table for generations to come. No wonder Warren Buffett just pulled up a chair.
Originally posted 2018-05-04 20:59:49.