- I’ll give a long-term perspective on Apple, something that most analysts miss.
- It’s all about the ecosystem.
- There’s a big possibility the returns will be better than 10% per year from the current level.
Yesterday we discussed Warren Buffett’s most recent letter to shareholders. In that letter Buffett made clear how he’s finding it very difficult to find sensibly priced investments, so it’s interesting to think about why he has been buying Apple (NASDAQ: AAPL).
In Q4 2017, Buffett bought 31 million shares of AAPL and increased his stake to $28 billion making AAPL 14.6% of Berkshire’s stock portfolio.
Buffett broke his rule about never investing in tech stocks when he bought IBM, and that didn’t end well as he has sold most of his IBM holdings. But AAPL might be different. Let’s see why.
AAPL’s price to earnings ratio is 18 which might be a bit high for Buffett, but the company is constantly doing buybacks and growing revenues. As we know, Buffett likes to have a long term view on things so the question we have to ask ourselves if we want to figure out why Buffett is buying AAPL is this: where will AAPL be in 10 years?
Will AAPL deliver a 10% return on investment over the next 10 years? As long as there is a positive outlook,—and Buffett has said that he can see AAPL’s future much better than he can IBM’s—he will continue to buy.
Let’s try to look at things through the same lens.
Where Will AAPL Be In 10 Years?
What Buffett likes is a moat and a good return on capital. AAPL’s moat lies in its extremely high customer retention rates.
According to a JP Morgan survey, 92% of iPhone customers will buy another iPhone while a Comcast survey indicated a 96% rate. A 92%-96% retention rate and an installed base of 1.3 billion devices is something extremely impressive and probably what Buffett focuses on. When you have 1.3 billion dedicated customers, you will find a way to increase the value you give them and how to get more in return from them.
AAPL’s services revenue was up 18% last year and they are on schedule to double their 2016 services revenue by 2020. If they continue on that pace up to 2028, services might be the biggest component of AAPL’s revenue.
On top of that, we can’t possibly have an idea where the technology AAPL is developing now will go and what they will develop in the future will bring the company. But perhaps the key in Buffett’s interest lies in the financial part of the company. Perhaps it reminds him of the early days of American Express.
Apple Pay – Apple Insurance?
Apple Pay has seen 50% growth in merchant adoption and you can use it in more than 50% of American retail locations. As it’s likely we will carry just our phones and no wallets in the future, it’s easy to see where the value lies here.
With an installed base of 1.3 billion customers, the ecosystem is there to build on for the very long term. Perhaps this is the key component Buffett is interested in. If things remain as they are now, he gets a company with massively positive cash flows, high returns on capital, great technology, buybacks, and dividends. If things really explode to the upside and the company monetizes its customer base through its services, we could easily see strong double digit growth over the next decade.
If that happens and AAPL grows by 10% per year over the next 10 years, its revenue would go from $229 billion (2017) to $600 billion.
Given that the margins on all of AAPL’s businesses are pretty strong, if we apply the current 21% net profit margin on AAPL’s 2027 estimated revenue, we get $125 billion. If the company continues to do buybacks and we estimate it to buy back 3% of the outstanding shares per year, AAPL’s EPS would be $32 in 2028.
So that’s why Buffet has been buying Apple since it was below $100 and is still buying it now at above $170. The return on invested capital is high and that is what makes AAPL a great investment no matter the current price. If AAPL gets to a valuation of 20 in 2027, the $32 in EPS would make it a $640 stock for a market capitalization close to $2.5 trillion.
What’s very interesting is that few think in a similar way about AAPL. There is so much to discuss when the focus is on the short term that it’s easy to lose sight of the long term. And most analysts are just focused on the short term issues.
What Analysts Can’t See Or Don’t Look For
If I go through the questions from the Q4 2017 earnings conference call, they are mostly about the capital structure, iPhone demand and pricing ($1,000 vs. $400), March quarter guidance, the weaker dollar, how the iPhone replacement cycle is elongating, the tax rate, the new home pod, trends in China, and net cash.
Mike Olson from Piper Jaffray was the only analyst who asked about future products and how the management sees how augmented reality will fit into AAPL’s future.
Comparing AAPL To Others
A quick ecosystem comparison will show how AAPL is undervalued from a long-term ecosystem perspective.
So if you look for a good long term investment that already offers a relatively good return and has huge potential, look no further than AAPL or BRK which is full of such companies.