Surprising news has just come out of Omaha. Warren Buffett sold half of Berkshire Hathaway's monster stake in Apple (AAPL -0.05%), raising tens of billions of dollars to add to the company's cash heap. At the end of last quarter, Berkshire Hathaway had $277 billion in cash and equivalents, giving it one of if not the world's largest cash pile for an individual company.
Berkshire's Apple investment was worth $84 billion at the end of the second quarter, down from $150 billion a few years ago. What is Buffett planning to do with Berkshire's cash? Why has he soured on Apple? And should you do the same for your portfolio? Let's take a closer look and find out.
Stagnating sales growth
Apple reported earnings on Aug. 1 for the second calendar quarter of 2024. Its results have looked similar for the last few quarters. Hardware revenue has stagnated, with iPhone, iPad, and Wearables revenue all down in the first nine months of this Apple fiscal year versus the prior year. The only bright spot was the Mac, but that was a slight increase in sales.
On a positive note, Apple Services revenue continues to climb. Revenue for the segment hit $71 billion over the last nine months, up from $63 billion in the same period a year prior. Services are higher margin for Apple and come from App Store fees, advertisements, Apple TV, and other software programs that it sells to customers. This has been the story for Apple for a long time. Even though Apple is not growing hardware sales, these new software products will drive growth for the company.
Looking holistically, Apple's sales have not gone anywhere for a while. After the COVID-19 pandemic boost, revenue has been flat over trailing 12-month periods for a few years. In fact, revenue is still down from its peak at the end of 2022. One key reason for this is China. The region is important for Apple and has a weak consumer economy right now. Revenue in the first nine months of this fiscal year was $52 billion in China compared to $57.5 billion a year ago.
AAPL Revenue (TTM) data by YCharts
Uncertain future for Services income
Apple's Services business looks like all sunshine and rainbows, driving margins higher and higher. However, a good chunk of Apple's Services revenue is simply a distribution payment from Google Search to be the default search engine on Safari. Apple reportedly receives over $20 billion a year from Alphabet for this distribution agreement, which comes at close to 100% profit margins. Analysts estimate that this payment may make up 15% of Apple's consolidated earnings power.
Now, there is risk this payment deal will come apart. A judge just ruled that Google Search's default distribution agreements are monopolistic, siding in the U.S. government in its case vs. Alphabet. This could be bad news for Alphabet, but it is even worse news for Apple. If it loses this distribution deal, it will see an estimated 15% of its profits evaporate overnight. And that is with stagnating top-line growth. The one gem of its business -- Services -- could turn into a dud within a few years if the courts rule against Apple.
AAPL PE Ratio data by YCharts
The stock looks expensive
Even though Apple's revenue is stagnating and its high profit distribution payment is at risk of imploding, the stock was at an all-time high at the end of the second quarter. It is no surprise, then, to see Buffett selling some of his position.
Today, the stock is a tad lower due to the broad market downturn. However, it still trades at an expensive-looking price-to-earnings ratio (P/E) of 31.5. That is much higher than the S&P 500 average for a company with stagnating sales. Buffett likes to buy businesses closer to a P/E of 10, which is when he started buying Apple shares eight years ago.
He clearly still likes the business -- it is Berkshire Hathaway's largest equity holding -- but the stock is very expensive at these prices. A low-growth stock with uncertainty around a large chunk of its profits and cash flow (the Google antitrust case) does not deserve to trade at over 30x earnings. Even Apple. Buffett understands this, which is why he is trimming his position. He would rather sit in short-term U.S. treasury bills that pay him a guaranteed 5% interest rate every year.
If you hold Apple, this doesn't mean you should immediately sell your position. But if it is an outsize position in your portfolio like at Berkshire Hathaway, it might be smart to diversify your holdings like Buffett.
