Why Warren Buffett has piled into Apple

He's one of the most successful investors of all-time, loved by academics and the financial press alike for his dictionary of usable quotes. Perhaps the most popular involves something about being "fearful when others are greedy and greedy when others are fearful". It explains why Warren Buffett has just admitted piling into tech loser Apple.

In a regulatory filing Monday, Buffett's investment vehicle owned up to paying over $1 billion (£694 million) for 9.81 million shares in the iconic smartphone and device maker.

Now, Buffett has famously steered clear of technology stocks. Yes, he has a big stake in IBM, but that's about it. So for Berkshire Hathaway to place such a significant bet on Apple at this point in the cycle is a surprise.

And the investment has had poor start. Berkshire paid an average price of $109 for every Apple share. They were worth just $89.47 last week, down 18% and at their lowest since June 2014. That gave Buffett a paper loss of over $103 million, and even now, with the shares up at $93.57, he's still 14% down.  

Of course, it wouldn't be the first time Buffett had got it wrong. Buying Tesco was not his best idea, and it cost the billionaire investor a cool £288 million as he flogged shares in the supermarket struggler through 2014 at a "leisurely pace".

We asked last month whether Apple's rotten second quarter spelled value. "The price/earnings multiple, based on EPS forecasts of $8.92 for the year to September 2016, is a modest 11 times, dropping to single digits in 2017," we noted, but believed "the market is unlikely to ascribe a more aggressive rating until it's confident Apple can avoid more nasty surprises like this.

"Technical support stretching back to 2013 is currently being put to the test." (See charts)

Well, that support gave way pretty quickly and now forms a line of resistance which must be bettered if Buffett is to make his money back.

And there are plenty who have doubts about Apple right now, less than three weeks after it reported a 13% drop in quarterly revenue and a worrying 26% plunge in Greater China. Earnings per share (EPS) of $1.90 also missed estimates and Apple's own forecasts for third-quarter revenue of $41-$43 billion is well before expectations.

"History would suggest it will be a tough bet to assume that a consumer electronics company will remain the world's most valuable franchise," says Sebastian Radcliffe, manager of the Jupiter North American Income fund.

"This reflects not just the creative destruction that is particularly acute in some industries, but also the way some companies have cycles of over-earning that make their shares much more expensive than is originally apparent."

However, not for nothing do they call him the Sage of Omaha. Buffett is a long-term investor and won’t be fazed by miss-timing this stock purchase.

And Steven Milunovich at UBS thinks the 85-year-old has called it right, despite concerns about iPhone growth and weakness in China.

"Apple is valued as a traditional legacy vendor, likely underestimating its optionality," says the analyst. "At under 10 times ex-cash and with little implied long-term growth, the stock trades at a valuation similar to legacy pipeline computer companies, in our view undervaluing its platform potential."

Milunovich prices Apple shares at 14 times EPS forecasts for 2016, or 12 times for 2017, giving a price target of $120. Buffett will be looking for much more.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.