Hailshadow/iStock via Getty Images
My last article on Apple (NASDAQ:AAPL) and Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B) is co-produced with Sensor Unlimited and published about a month ago in early November. That article argued that share repurchases at both AAPL and BRK are far more potent when considered together than viewed separately. Such “double buybacks” are compounding on steroids in our view.
In this article, we want to switch the focus entirely. We will argue A) why buying/adding AAPL around its current price (which translates to about 20x owners’ earnings) is a no-brainer, and B) why owning AAPL via BRK is an even better idea.
Both AAPL and BRK have posted strong Q3 earnings. The key results are shown in the two charts below, and I will dive into the highlights as we go. These strong results, when combined with the price corrections during Q3 due to (or thanks to) market volatilities, investors have some great opportunities to buy or add these perpetual compounders at enticing entry valuations.
For AAPL, its TTM EPS as of Q3 2022 (i.e., its FY Q4) came in at $6.11 per share as you can see from the first chart below. Later, you will see that such accounting EPS underestimates its owners’ earnings (“OE”), and its OE is around $7.18, which translates into a share price near ~$145 at a 20x OE multiple. And I kept telling my readers buying/adding stock like AAPL near or below 20x OE is a no-brainer. Stocks like AAPL (or BRK) are quintessential examples of equity bonds as explained in my earlier article because:
To me, any valuation near or below 20x OE is very attractive for a stock with ROCE (return on capital employed) near 100% like AAPL. At about 100% ROCE, a 5% investment rate would provide 5% organic real growth rates (i.e., before inflation adjustments). And a 20x OE would provide about 5% owners earnings yield, leading to a total return in the double digits. Once you adjust for the risks (and I consider the risks from AAPL similar to treasury bonds), a 10%+ annual return is ~3x of what you can get from bonds in the long term.
In this article, I will focus on an alternative way to own AAPL, a sort of backdoor, through BRK. And I will explain why owning AAPL this way is even more attractive under current conditions. And this brings me to the financials of BRK, as shown in the second chart in this section.
Source: AAPL Q3 ER
BRK reported strong operating results for Q3 also and is on pace for a solid 2022. Operating earnings per share, which excludes capital gains and losses from the investment portfolio, clocked in at $3.00 in Q3, translating into an annual growth rate of almost 20% YOY. This was particularly impressive considering that its insurance segment suffered higher-than-usual operations losses due to hurricane Ida, Ian, and also the floods in Europe. The remainder of this analysis also will involve its balance sheet, which is posted below. And a couple of highlights relevant to the subsequent analyses:
With these parameters, let’s dive in and see how we can own AAPL through BRK at an effective PE of ~12x or below.
Source: BRK Q3 ER
Since we are analyzing AAPL and BRK, it’s only fitting to start with a quote from Warren Buffett on the difference between accounting EPS and owners’ earnings (“OE”). The following is taken from Berkshire Hathaway’s 1986 annual report (slightly edited with emphases added by me):
These represent (“a”) reported earnings plus (“b”) depreciation, depletion, amortization, and certain other non-cash charges…less (“c”) the average annual amount of capitalized expenditures for plant and equipment, etc. that the business requires to fully maintain its long-term competitive position and its unit volume…Our owner-earnings equation does not yield the deceptively precise figures provided by GAAP, since (“c”) must be a guess – and one sometimes very difficult to make. Despite this problem, we consider the owner earnings figure, not the GAAP figure, to be the relevant item for valuation purposes…All of this points up the absurdity of the ‘cash flow’ numbers that are often set forth in Wall Street reports. These numbers routinely include (“a”) plus (“b”) – but do not subtract (“c”).
The key is to estimate item c, and my analysis of item c for AAPL is shown in the table below. This table is based off Bruce Greenwald’s method (detailed in his book Value Investing) to separate maintenance capex and growth capex. Readers interested in the details could find them in my earlier article or his book.
To wit, AAPL’s TTM accounting EPS came in at $6.11 per share as aforementioned. However, its OE is about $7.18 per share, about 18% higher. The reason for this higher OE is the accounting EPS considered all CAPEX to be a cost, while only the maintenance capex should be considered as costs as Buffett explained above. In AAPL’s case, the discrepancy should be obvious as its accounting EPS is even lower than its FCF (free cash flow) by about 13%, and then even the FCF is an underestimate of the true OE (again because the FCF calculation also considered all the capex expenses to costs). The third column in the table shows my forecast for the next year. And as you can see, the OE for Apple in the next year is projected to be $7.33 per share.
All told, Apple’s accounting PE is about 23x, a number all AAPL investors must be very familiar with. However, once you consider its OE, then the multiple is actually on the order of 20x for this year and slightly below 20x on an FW basis.
Then finally, remember that Apple also carries a net cash position on its balance sheet (about $2.27 per share under its current conditions). Once you adjust the cash position too, its OE PE is on the order of 19.9x for this year and only 19.5x for next year.
And in the next section, we will see how we can do even better through BRK.
Source: Author based on Seeking Alpha data.
As mentioned earlier, the market value of BRK’s equity investment portfolio (based on dataroma) is at $296.1B As of this writing. AAPL is the largest position and is valued at $123.6B. So BRK’s equity investment excluding AAPL is worth about $173B, or $77 per share. The market capitalization for BRK is about $701B ($315 share price). Then also recall from its balance sheet, we know that there is $109 billion worth of cash sitting on its ledger.
Putting all these above numbers together, we can show that:
Source: Author based on Seeking Alpha data.
BRK is projected to earn $12.9 per share of operating income in 2022, although 2022 may not be the most representative year. My best estimate for its normalized operating income is about $12 per share (or $26.7B in total), which is the assumption that I used in the analysis shown in the following table.
Source: Author based on Seeking Alpha data.
Now just as established above, if we buy BRK shares at $315, we are effectively buying 0.40 AAPL shares (or 0.41 on an FW basis) and all the BRK operating segments for $189. The BRK operating segments would provide earnings of $12 per share as assumed above, and the 0.4 AAPL shares would provide an OE of $2.88 (=0.40*$7.18). Thus, we paid $189 and got a total of $14.88 per share of OE ($12 from BRK operations plus $2.88 from AAPL). On an FW basis, the earnings would further increase to $15.13 per share due to a combination of AAPL earnings growth and BRK’s share repurchases as discussed above.
Now, how you compute the PE multiple here depends on how you value BRK’s operating income. The last row of the table shows an aggregated average, a sort of effective “ownership” PE of AAPL and BRK together, which turned out to be 12.7x based on 2022 financials and 12.1x on an FW basis.
If BRK’s operating income is priced at a 15x multiple – a quite reasonable multiple in my view, then BRK’s operating income would be worth $180 per share. Hence, we would be paying only $9 ($189-$12*15) for the 0.4 AAPL share, which provides $2.88 of OE. This means we would be owning the AAPL shares at a PE of about 3.1x only.
Specific risks for AAPL or BRK have been thoroughly discussed in other SA articles (including some of our own), and I won’t further add them here. Here I will focus on the risks and limitations associated with the particular backdoor idea described in this article.
Nonetheless, it’s always better to be approximately right than precisely wrong. And the bigger picture I see here are:
As you can tell, our core style is to provide actionable and unambiguous ideas from our independent research. If your share this investment style, check out Envision Early Retirement. It provides at least 1x in-depth articles per week on such ideas.
We have helped our members not only to beat S&P 500 but also avoid heavy drawdowns despite the extreme volatilities in BOTH the equity AND bond market.
Join for a 100% Risk-Free trial and see if our proven method can help you too.
This article was written by
** Disclosure: I am associated with Sensor Unlimited.
** Master of Science, 2004, Stanford University, Stanford, CA
Department of Management Science and Engineering, with concentration in quantitative investment
** PhD, 2006, Stanford University, Stanford, CA
Department of Mechanical Engineering, with concentration in advanced and renewable energy solutions
** 15 years of investment management experiences
Since 2006, have been actively analyzing stocks and the overall market, managing various portfolios and accounts and providing investment counseling to many relatives and friends.
** Diverse background and holistic approach
Combined with Sensor Unlimited, we provide more than 3 decades of hands-on experience in high-tech R&D and consulting, housing market, credit market, and actual portfolio management. We monitor several asset classes for tactical opportunities. Examples include less-covered stocks ideas (such as our past holdings like CRUS and FL), the credit and REIT market, short-term and long-term bond trade opportunities, and gold-silver trade opportunities.
I also take a holistic view and watch out on aspects (both dangers and opportunities) often neglected – such as tax considerations (always a large chunk of return), fitness with the rest of holdings (no holding is good or bad until it is examined under the context of what we already hold), and allocation across asset classes.
Above all, like many SA readers and writers, I am a curious investor – I look forward to constantly learn, re-learn, and de-learn with this wonderful community.
Disclosure: I/we have a beneficial long position in the shares of BRK.B,AAPL either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.