The Oracle of Omaha reveals his Apple Buy Strategy, and it is based on stock buybacks.
I mentioned in a previous post that I couldn't get my head around Warren Buffett buying Apple stock. It didn't seem like a real fit for his strategy of owning conventional old-line companies. He literally owns brick and mortar, print newspapers, and things like See's Candies (no relation). He missed out on the tech boom, famously avoiding Google and Amazon. Maybe this is his way of getting into tech too late? Or has Apple matured to the point where it is as boring as a brick company?
In a recent CNBC article, Buffett reveals his strategy, see if you can find the glaring flaw in it:
"When I buy Apple, I know that Apple is going to repurchase a lot of shares," he said. "We own about 5 percent. But I know I don't have to do a thing and probably in a couple of years we'll own 6 percent without laying out another dollar. Well, I love the idea of having 5 percent go to 6 percent. The cheaper the stock is the more they will get for their money. There is no reason at all for me to encourage other people to buy Apple."
Hmm... The problem is, by purchasing all those shares of Apple, and talking about it so much, Buffett is effectively encouraging people to buy Apple. So that sort of defeats the strategy of keeping the share price low, doesn't it? I wrote about share buybacks before - twice, actually three times. And sometimes this is a good sign, and sometimes it is not. It can even be a sign of fraud, although that is not the case with Apple (we hope!). Apple has a lot of overseas profits which can be repatriated thanks to the new tax law that Congress passed. And they could keep this money (increasing retained earnings, which could lead to tax problems for the company), pay it to shareholders in dividends, use it to pay down debt, invest in new technologies, or buy back shares. And at least in part, Apple seems poised to do the latter.
Now, whether this really means Buffet will get a free 1% of the company for "doing nothing" remains to be seen (And by the way, something-for-nothing seems to go against the "Buffett way.") If the shares are bought back and retired, then his stake in the company may increase permanently. But if the company holds the shares and re-sells them in the future to raise capital, then the gain may be only temporary.
Note that by purchasing Apple stock, Buffett is raising awareness of Apple, which by itself will raise the share price. It is likely that he could sell his shares today and walk away with billions in profits, or at least hundreds of millions. That's the problem - as I noted before - with venture capitalism. If you have enough money, you can change markets by your purchases and sales of stocks, and thus manipulate prices. As Buffet put it, "the first billion is the hardest" as you actually have to work for it. After that, you can simply throw your weight around and make more money. Seems fair, right?
Is Apple a good buy? Perhaps. The P/E ratio is below 20, which is pretty astounding for a tech company. Or maybe this means it no longer is a "high-tech" company but an old-line company about as boring as a tractor factory. While smart phone sales are sort of flattish, the company is making money on services. And some are betting that the hardware end of things may turn into a commodity business (as I think it already has) and the real growth is going to be in payment systems, music streaming, and other services that people (and merchants) will pay for over time.
Buffett famously said he likes businesses with "moats" - steep barriers to entry to tamp down competition. How this applies to See's Candies, I do not know, other than maybe they are the only candy company that sells at airports. But things like music streaming, for example, could be profitable for Apple where it is not profitable for Spotify or Pandora. A recent article illustrates the problems for smaller streaming services - the copyright holders keep raising the rates as these streaming companies start to show any chance of profit. But the author notes that larger players, such as Apple, could have the market power to fight copyright holders to the mat.
In terms of things like payment systems and the like, it is go big or go home. You can't run a Mom-and-Pop online payment system for very long - it has to be widely used and accepted everywhere in order to work. So you need a lot of market power, a lot of money behind you, and a brand name that people recognize. And Apple might be that brand name - we'll see.
But whether Buffett is buying Apple for the long haul remains to be seen. This stock buyback might be a one-time deal, not an ongoing process. Once the overseas profits are returned to the States and the stock is bought back, will Buffett sell off his stake (a little bit at a time, of course!) or hang on for the long haul? Interesting questions. I am not sure I know the answers.
And as I noted before, never invest in things you don't understand. And I am still not sure I understand Buffet's strategy here.