Apple remains Buffett's biggest public stock holding, but his thesis about its moat faces questions

Berkshire Hathaway's Warren Buffett was still using a flip phone as late as 2020, four years after his investment behemoth started amassing a huge stake in the company that makes iPhones.

"I don't understand the phone at all, but I do understand consumer behavior," Buffett said last year at Berkshire's annual shareholder meeting in Omaha, Nebraska.

He's emerged in recent years as one of Apple's top evangelists.

At the end of 2023, Berkshire owned about 6% of Apple, a stake worth $174 billion at the time, or about 40% of the conglomerate's total value. That's about four times bigger than Berkshire's second-biggest public stock holding, Bank of America, and makes the company the No. 2 Apple shareholder, behind only Vanguard.

As Berkshire investors and fanboys of the 93-year-old Buffett flood Omaha this weekend for the 2024 annual meeting, Apple is likely to be a hot topic of discussion. The tech giant on Thursday reported a 10% year-over-year decline in iPhone sales, leading to a 4% drop in total revenue. But the stock had its best day since late 2022 on Friday due largely to a $110 billion stock buyback plan and increased margins that result from a growing services business.

The bet on Apple and CEO Tim Cook has paid off handsomely for Buffett, who said in 2022 that the cost of Berkshire's Apple stake was only $31 billion. His firm is up almost 620% on its investment since the start of 2016.

Despite being a self-described Luddite, Buffett has long had a coherent non-techie thesis for loving Apple. He's seen how devoted Apple users are to their devices, and has viewed the iPhone as an extraordinary product that could keep its customers spending inside the Apple ecosystem. He calls it a moat, one of his favorite words for describing his preferred businesses.

"Apple has a position with consumers that they're paying $1,500 or whatever it may be for a phone, and these same people pay $35,000 for a second car," Buffett said at last year's meeting. "And if they had to give up their second car or give up their iPhone, they'd give up their second car!"

Data is in his favor. According to a study from Consumer Intelligence Research Partners, Apple benefits from 94% customer loyalty, meaning that nine out of 10 current U.S. iPhone owners choose another iPhone when buying a new device.

Buffett also has hailed Apple's ability to return billions of dollars to shareholders annually through share buybacks and dividends, a capital allocation strategy for which the billionaire investor may have himself to thank. When the Apple CEO was asked in a 2016 interview with The Washington Post who he turns to for advice at pivotal moments, Cook offered up a story about his relationship with Buffett.

"When I was going through [the question of] what should we do on returning cash to shareholders, I thought who could really give us great advice here? Who wouldn't have a bias?" Cook said. "So I called up Warren Buffett. I thought he's the natural person."

Apple has shown its appreciation for the Oracle of Omaha in other ways.

In 2019, the company published an original iPhone game called "Warren Buffett's Paper Wizard" in which a paperboy bikes from Omaha to Apple's hometown of Cupertino, California.

But with Apple's business having declined in size in five of the past six quarters and with the company expecting just low single-digit growth in the current quarter, Buffett may face questions this weekend at the shareholder meeting about whether he still sees the same power in the moat, particularly with regulatory pressures building around tech's mega-cap companies.

Buffett trimmed his stake in Apple late last year, though only by about 1%. Even after Friday's rally, the stock is down 3.8% in 2024, while the S&P 500 is up 7.5%.

Berkshire's initial foray into Apple in 2016 was not Buffett's idea. Rather, the investment was led by Ted Weschler, one of his top deputies, and was seen as a passing of the torch to the next generation of Berkshire investment managers.

But the following year, Berkshire started purchasing even more Apple shares, and Buffett began talking it up. He said he liked the stock and the company's "sticky" product, although he didn't use it.

In 2018, he said Apple users are "very, very, very locked in, at least psychologically and mentally" to the product and the ecosystem.

"Apple has an extraordinary consumer franchise," he said.

At last year's annual meeting, when asked how Berkshire can defend having Apple make up so much of its public portfolio, Buffett said, "It just happens to be a better business than any we own." He also hailed Cook, calling him one of the "best managers in the world."

A number Apple likes to use to tout the health of its business, despite the declining revenue, is "2.2 billion." That's how many devices the company says are currently in use and points to the massive customer base available as Apple rolls out new subscription services.

"Once customers get into the ecosystem, they don't leave. So it's not a speculative tech play," said Dan Eye, chief investment officer at Fort Pitt Capital Group, which owns Apple shares. "It's kind of more like an annuity and I think that's what Warren Buffett really sees as well."

In addition to the drop in revenue, Apple faces new challenges from regulations and weak overseas markets, as well as from Microsoft and Google's advancements in artificial intelligence. For regulators, the concern surrounds the very moat that Buffett finds so attractive, and whether it gives the company monopolistic control in the smartphone market.

The U.S. government in March alleged that Apple designs its business to keep customers locked in. The Department of Justice's lawsuit claimed that products like Apple Card, the Apple Arcade game subscription, iMessage and Apple Watch work best or only with an iPhone, creating illegal barriers to competition and making it harder for consumers to switch when it's time for an upgrade.

However, the litigation is expected to take years, pushing any potential penalties to Apple and its products well into the future. In the meantime, there's no sign that the iPhone is becoming less important as new devices like virtual reality goggles have found only niche audiences, while consumer AI products have failed to take off.

Buffett hasn't voiced his view publicly on Apple's regulatory hurdles, and this will be the first opportunity for investors to ask him about the issue since the DOJ's lawsuit. But Buffett knows a little something about regulation — two markets where he's most active are railroads and insurance.

In a note to clients earlier this month, Bernstein analyst Toni Sacconaghi didn't go deep on regulatory concerns, but mentioned that he doesn't believe the DOJ suit will "seriously threaten" the strength of Apple's ecosystem. He also said that following Buffett's lead on getting in and out of Apple is a solid strategy for making money.

"Despite his reputation as a long term buy and hold investor, Warren Buffett has been remarkably disciplined at adding to his Apple position when it is relatively cheap and trimming when it is relatively expensive," Sacconaghi wrote. He encouraged investors to "be like Buffett."

Odds are that Buffett was thrilled with Apple's announcement this week regarding its expanded repurchase program. It's a practice he's long adored.

"When I buy Apple, I know that Apple is going to repurchase a lot of shares," he said in 2018. 

And he likes to note how buybacks result in getting a bigger stake in the company without buying more shares.

"The math of repurchases grinds away slowly, but can be powerful over time," Buffett said in 2021.

Apple also increased its dividend by 4%, and signaled that it would continue to lift it annually.

Buffett was effusive about the tech giant's capital-return strategy at the conglomerate's annual meeting last year, pointing out that it helped Berkshire own a bigger piece of the pie. Unlike insurance company Geico and homebuilder Clayton Homes, which his firm owns in their entirety, Berkshire can continue to increase its stake in Apple, a fact he reminded investors of at the meeting.

"The good thing about Apple is that we can go up," Buffett said.