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2021-08-11
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Apple Inc. And Buffett: Why He Bought And Why He Holds
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{"i18n":{"language":"zh_CN"},"detailType":1,"isChannel":false,"data":{"magic":2,"id":892191604,"tweetId":"892191604","gmtCreate":1628642279208,"gmtModify":1631890436301,"author":{"id":3561932898161790,"idStr":"3561932898161790","authorId":3561932898161790,"authorIdStr":"3561932898161790","name":"ChoongHwee","avatar":"https://static.laohu8.com/default-avatar.jpg","vip":1,"userType":1,"introduction":"","boolIsFan":false,"boolIsHead":false,"crmLevel":2,"crmLevelSwitch":0,"individualDisplayBadges":[],"fanSize":6,"starInvestorFlag":false},"themes":[],"images":[],"coverImages":[],"extraTitle":"","html":"<html><head></head><body><p>Good</p></body></html>","htmlText":"<html><head></head><body><p>Good</p></body></html>","text":"Good","highlighted":1,"essential":1,"paper":1,"likeSize":3,"commentSize":1,"repostSize":0,"favoriteSize":0,"link":"https://laohu8.com/post/892191604","repostId":1138697562,"repostType":4,"repost":{"id":"1138697562","kind":"news","pubTimestamp":1628642042,"share":"https://www.laohu8.com/m/news/1138697562?lang=&edition=full","pubTime":"2021-08-11 08:34","market":"us","language":"en","title":"Apple Inc. And Buffett: Why He Bought And Why He Holds","url":"https://stock-news.laohu8.com/highlight/detail?id=1138697562","media":"Seeking Alpha","summary":"Summary\n\nThis article analyzes Apple under the context of it being the largest holding in the Buffet","content":"<p>Summary</p>\n<ul>\n <li>This article analyzes <a href=\"https://laohu8.com/S/AAPL\">Apple</a> under the context of it being the largest holding in the Buffett portfolio.</li>\n <li>This analysis approaches the purchase under a framework that I call the Buffett’s 10x Pretax Rule.</li>\n <li>And this analysis argues that Buffett holds the AAPL shares in the long term for its perpetual growth prospects, offering double-digit return even under its current expensive valuation.</li>\n</ul>\n<p><img src=\"https://static.tigerbbs.com/24b65798f03c6f9376257bba2741e588\" tg-width=\"768\" tg-height=\"531\" referrerpolicy=\"no-referrer\" width=\"100%\" height=\"auto\">Justin Sullivan/Getty Images News</p>\n<h3><b>The investment thesis</b></h3>\n<p>If you are reading this, chances are that you already know that AppleInc. (AAPL) is the largest position in Warren Buffett's Berkshire Hathaway portfolio. When many people wonder if the legend has lost his magic touch, and commented on his blunders with the airline stocks, they forgot that he made more than $100B from AAPL stocks alone! With his concentrated investment style, what he lost on the relatively minor bets such as the airlines is only a footnote.</p>\n<p>This article analyzes AAPL under the context of it being the largest holding in the Buffett portfolio. This analysis first approaches his entry decision under a framework that I call the Buffett’s 10x Pretax Rule. And then this analysis argues that Buffett holds the AAPL shares in the long term NOT as a technology stock – he had made it clear enough that he does not understand tech companies and will not invest in them. He must be holding AAPL for its perpetual growth prospects. From this perspective, we will see that APPL will still offer double-digit return in the longer run even under its current expensive valuation.</p>\n<p><img src=\"https://static.tigerbbs.com/348a1fb56faeceb8e956ad8f6fa3b09a\" tg-width=\"640\" tg-height=\"645\" referrerpolicy=\"no-referrer\" width=\"100%\" height=\"auto\"></p>\n<p>Source: DataRoma</p>\n<h3><b>Buffett’s 10x Pretax Rule</b></h3>\n<p>If you’re a devout Buffett cultist like this author, you must have noticed or heard that the grand master paid ~10x pretax earnings for many of his largest and best deals. The list is a really long one, ranging from Coca-Cola, American Express, Wells Fargo, Walmart, Burlington Northern, and of course the more recent AAPL purchase and his recent $25B repurchases of BRK.A shares as analyzed in my earlier article.</p>\n<p>The following chart shows the price history of AAPL and its 10x pretax earning since 2010. Pretax earnings are also referred to as \"EBT\", Earning Before Taxes, in this article. As seen, Buffett made his purchases during 2016-2017 when the price is below or near 10x EBT. I was lucky enough to have made the AAPL purchases at that time myself too.</p>\n<p>Buffet himself also mentioned and discussed the 10x pretax multiple times in his shareholder meetings and Q&A sessions. An example quote is provided below (highlighting was added by me):</p>\n<p>Buffett: “Geico would be valued differently than Gen RE and other insurance businesses because it’s rational to assume a large underwriting profit and significant growth. You cannot say that about many insurance businesses. I would love to buy a new bunch of operating businesses with similar competitive positions to the ones we own now at nine to ten times pretax earnings.”</p>\n<p><img src=\"https://static.tigerbbs.com/9eec812a3eda60f950a1890eebc7dd34\" tg-width=\"640\" tg-height=\"359\" referrerpolicy=\"no-referrer\" width=\"100%\" height=\"auto\"></p>\n<p>Source: author based on Seeking Alpha data</p>\n<p>So are there any reasons fundamental to this 10x pretax rule, or is it only a bunch of pure coincidences? I think it is the former and there are indeed many good reasons for this rule, as listed below.</p>\n<h3><b>First, Why pretax?</b></h3>\n<p>Out of all the earning metrics, EPS, operation income, free cash, dividend, etc., why do we favor the pretax earning? I think there are at least two good reasons.</p>\n<ul>\n <li>After tax earnings do not reflect business fundamentals. Taxes can change from time to time due to factors that have no relevance to business fundamentals, such as tax law changes and capital structure change. Plus there are plenty of ways to lower the actual tax burden of a company.</li>\n</ul>\n<ul>\n <li>Pretax earnings are easier to benchmark, say against bond earnings. The best equity investments are bond like, and when we speak of bond yield, that yield is pretax. So a 10x EBT would provide a 10% pretax earning yield, directly comparable to a 10% yield bond.</li>\n</ul>\n<h3><b>Second, why 10x?</b></h3>\n<p>Besides being a nice and round number, it passes the/my common sense test. A 10x pretax multiple roughly translate into 12 to 15x PE depending on the tax rates, which is not far off from the long term average of stock valuation. Furthermore, if we buy average business at 10x pretax, we already get a 10% pretax return. And if we can do better than buying only average business (like Buffett), paying 10x pretax pretty much guarantees double digit pretax earning. Of course, the 10x here is only for businesses that are conservatively leveraged (say with interest coverage around 10x). The number needs to be adjusted for a highly leveraged business or a business with loads of cash.</p>\n<h3><b>Third, warning and summary</b></h3>\n<p>Here a strong warning is in order. I am NOT suggesting you go out and start buying every/any stock that is below 10x EBT. As investors, we face many risks. Two of the major risks are A) quality risk or value trap, i.e., paying a bargain price for something of horrible quality, and B) valuation risk, i.e., paying too much for something of superb quality. The 10x pretax rule is mainly to avoid the type B risk AFTER the type A risk has been eliminated already.</p>\n<p>So to summarize, to apply the 10x EBT rule,</p>\n<ol>\n <li>the business should have not existential issue in the long run. However, at the end, this is largely a subjective judgement.</li>\n <li>the business should have no existential issue in the short run either. This is can be quite reliably and objectively evaluated based on the cash flow and debt coverage.</li>\n <li>If we paid 10x pretax and bought a business that meets requirement 1 and 2, we will be paying an average price for an average business. Not the best investment ever, but 10% pretax return is not that bad either. If we get a business that offers ANY growth, then we will be buying an above average business at an average price. And we will have a large chance of a double digit return compounding for a long time (if you hold onto to it long enough like Buffett).</li>\n</ol>\n<p>AAPL in 2016 and 2017 obviously met all of the above requirements, and it is another textbook illustration of Buffett’s value driven investment success.</p>\n<h3><b>AAPL: why is he still holding it?</b></h3>\n<p>The next question now is: why is he still holding whenits valuation is not long 10x EBT? As a matter of factor, it is at ~23x EBT now, more than double 10x EBT.</p>\n<p>I am not going to pretend that I know all his considerations. There are so many aspects that needs to be considered with a position of this size - tax liabilities, alternative investment candidates, opportunity cost, et al.</p>\n<p>But I am pretty certain about one thing – he is NOT holding AAPL as a technology stock, wishing for the next technology breakthrough and double the earning. He had made it so clear that he does not understand tech companies and will not invest in them. He must be holding AAPL for its perpetual autonomous growth – a business that can almost “automatically” grow without the need of too much reinvestment.</p>\n<p>He said multiple times that there are businesses which, at the end of the day, point to a bunch of depreciated properties and equipment and tell the investors, “these are our profits.” He hates his business.</p>\n<p>As we will see from the next section, APPL is the exact opposite of those businesses. And due to its ultra-high ROCE and ultra-low requirement of reinvestment to fuel future growth, it will still offer double-digit return in the longer run even under its current expensive valuation.</p>\n<h3><b>Perpetual autonomous growth</b></h3>\n<p>If you, like this author, are a long-term investor who subscribes to the concepts of owner's earning, perpetual growth rate, and equity bond, then the long-term return is simpler. It is \"simply\" the summation of the owner's earning yield (\"OEY\") and the perpetual growth rate (\"PGR\"), i.e.,</p>\n<p>Longer-Term ROI = OEY + PGR</p>\n<p>Because in the long term, all fluctuations in valuation are averaged out (all luck at the end even out). And it doesn't really matter how the business uses the earnings (pay out as dividend, retained in the bank account, or repurchase stocks). As long as used sensibly (as AAPL has done in the past), it will be reflected as a return to the business owner.</p>\n<p>OEY is the owner's earnings divided by the entry price. All the complications are in the estimation of the owner's earnings - the real economic earnings of the business, not the nominal accounting earnings. Here as a crude and conservative estimate, I will just use the free cash flow (\"FCF\") as the owner's earnings. It is conservative in the sense that rigorously speaking, the owner's earnings should be free cash flow plus the portion of CAPEx that is used to fuel the growth (i.e., the growth CAPEx). At its current price levels, the OEY is ~3.6% for AAPL (~27.4x price to FCF).</p>\n<p>Again, the valuation is quite expensive and the OEY is merely 3.6%. But do not be under impressed yet, because there is a second part to the long term return, the part is the created by the PGR, perpetual growth rate. In the long term, the growth rate is:</p>\n<p>PGR = ROCE * Reinvestment Rate</p>\n<p>ROCE stands for the return on capital employed. Note that ROCE is different from the return on equity (and more fundamental and important in my view). ROCE considers the return of capital ACTUALLY employed, and therefore provides insight into how much additional capital a business needs to invest in order to earn a given extra amount of income – a key to estimate the PGR. The reinvestment rate is the portion of income the business plows back to fuel further growth.</p>\n<p>So to estimate the PGR, we need to estimate two things: ROCE and reinvestment rate.</p>\n<p>To estimate the ROCE of businesses like AAPL, I consider the following items capital actually employed:</p>\n<p>1. Working capital, including payables, receivables, inventory. These are the capitals required for the daily operation of their businesses.</p>\n<p>2. Gross Property, Plant, and Equipment. These are the capitals required to actually conduct business and manufacture their products.</p>\n<p>3. Research and development expenses (an essential expense for a business like AAPL).</p>\n<p>Based on the above considerations, the ROCE of AAPL over the past decade are shown below. As seen, it was able to maintain a respectably high ROCE over the past decade: it used to be 450% early in the decade and still hovers around an average of 150% in recent years since 2016. To put things in perspective, as detailed in myprevious articleforVisa Inc., another autonomous grower that Buffett likes, Visa features a ROCE “only” around 105%.</p>\n<p><img src=\"https://static.tigerbbs.com/d21191b41d6360f09d6f6496fac499a4\" tg-width=\"640\" tg-height=\"358\" referrerpolicy=\"no-referrer\" width=\"100%\" height=\"auto\"></p>\n<p>Source: author and Seeking Alpha.</p>\n<p>Now let’s see the reinvestment part. In recent years, the following is how AAPL has been allocating its operation cash (“OPC”). As seen, AAPL has been using on average ~33% of the OPC as maintenance CAPEx and dividend. So these two “mandatory” have been on average costing only 1/3 of AAPL’s operation cash in recent years. The quotation mark means even though dividend is usually considered an optional cost. But for a stock with AAPL’s status, management probably won’t cut it unless they really have to.</p>\n<p>For the remaining 2/3, the company does have a choice. It can use it for a variety of things: reinvest to fuel further growth, retain it to strength the balance sheet, pay an extra special dividend, pay down debt, buyback shares, et al. It obviously makes total sense to reinvest all of it to fuel further growth given its 150% ROCE. At this ROCE, $1 reinvested would be fuel $1.5 of additional earning! But the problem is that for businesses at this scale, there are just not that many opportunities to reinvest the earnings. As a result, AAPL has been allocating a part of the remaining earning, on average 70% in recently years, to buy back shares. Such repurchases, besides reflecting the confidence of the management on their own business, again also signals the lack of good reinvestment opportunities.</p>\n<p>But all things considered, with such spectacular ROCE, AAPL does not need that much reinvestment to grow, as elaborated below.</p>\n<p><img src=\"https://static.tigerbbs.com/190eeaa73f40d26feb7de2b4932718a8\" tg-width=\"640\" tg-height=\"343\" referrerpolicy=\"no-referrer\" width=\"100%\" height=\"auto\"></p>\n<p>Source: author and Seeking Alpha.</p>\n<p>With a 150% ROCE, it means that even if AAPL only reinvests 5% of its earning to expand the capital employed, it could maintain a 7.5% PGR (PGR = ROCE * fraction of earning reinvested = 150% * 5% = 7.5%). As aforementioned, this is a reason that AAPL can afford to use pretty much all the OPC for dividend and share repurchase after covering its maintenance CAPEx.</p>\n<p>Now we have both pieces of the puzzle in place to estimate the long-term return. At its current price levels, the OEY is estimated to be ~3.6%, and the PGR is about 7.5%. So the total return in the long term at current valuation would be a double digit 11% as shown in the chart below. Also as seen, even when ROCE fluctuates somewhat, the fluctuations wouldn’t change the long-term return dramatically.</p>\n<p><img src=\"https://static.tigerbbs.com/93688ad65495c50b51be46b2fcda963c\" tg-width=\"640\" tg-height=\"422\" referrerpolicy=\"no-referrer\" width=\"100%\" height=\"auto\"></p>\n<p>Source: author.</p>\n<h3><b>Conclusion and final thought</b></h3>\n<p>Many of Buffett's largest and best deals are purchased below or around 10x EBT, ranging from Coca-Cola, American Express, Wells Fargo, Walmart, Burlington Northern, and also the more recent AAPL purchase and his $25B repurchases of BRK.A shares.</p>\n<p>This article analyzes AppleInc.under the context as the largest purchase and also largest holding in the Buffett portfolio. This analysis approaches the purchase under a framework that I call the Buffett’s 10x Pretax Rule. The analysis showed that When Buffett purchased AAPL in 2016 and 2017, it met all the requirements for the 10x pretax rule and represented another textbook illustration of his value driven success.</p>\n<p>Then this article also attempted to answer why he is holding it given the current relatively expensive valuation. He is definitely NOT holding AAPL as a technology stock, wishing for the next technology breakthrough to double the earning. He must be holding AAPL for its perpetual autonomous growth – a business that can almost “automatically” grow without the need of too much reinvestment. From this perspective, the result show that these shares still can offer double-digit return even under its current expensive valuation.</p>\n<p>And as a final note before ending this section, this might be the most valuable insight that I’ve learned by studying Warren Buffett’s investment philosophy. The insight really is that I do not need a business with double-digit growth to generate double-digit returns. A reliable business that can offer a stable growth at a boring rate of a few percent (like ~5%) can already provide double-digit returns with good certainty as long as A) they are purchased at a reasonable valuation, and B) they have ROCE sufficiently high so that the growth can be driven by reinvesting a small fraction of the income. In the long run, assuming a growth rate more than 5% percent probably is a dangerous assumption to start with anyway.</p>","collect":0,"html":"<!DOCTYPE html>\n<html>\n<head>\n<meta http-equiv=\"Content-Type\" content=\"text/html; charset=utf-8\" />\n<meta name=\"viewport\" content=\"width=device-width,initial-scale=1.0,minimum-scale=1.0,maximum-scale=1.0,user-scalable=no\"/>\n<meta name=\"format-detection\" content=\"telephone=no,email=no,address=no\" />\n<title>Apple Inc. And Buffett: Why He Bought And Why He Holds</title>\n<style type=\"text/css\">\na,abbr,acronym,address,applet,article,aside,audio,b,big,blockquote,body,canvas,caption,center,cite,code,dd,del,details,dfn,div,dl,dt,\nem,embed,fieldset,figcaption,figure,footer,form,h1,h2,h3,h4,h5,h6,header,hgroup,html,i,iframe,img,ins,kbd,label,legend,li,mark,menu,nav,\nobject,ol,output,p,pre,q,ruby,s,samp,section,small,span,strike,strong,sub,summary,sup,table,tbody,td,tfoot,th,thead,time,tr,tt,u,ul,var,video{ font:inherit;margin:0;padding:0;vertical-align:baseline;border:0 }\nbody{ font-size:16px; line-height:1.5; color:#999; background:transparent; }\n.wrapper{ overflow:hidden;word-break:break-all;padding:10px; }\nh1,h2{ font-weight:normal; line-height:1.35; margin-bottom:.6em; }\nh3,h4,h5,h6{ line-height:1.35; margin-bottom:1em; }\nh1{ font-size:24px; }\nh2{ font-size:20px; }\nh3{ font-size:18px; }\nh4{ font-size:16px; }\nh5{ font-size:14px; }\nh6{ font-size:12px; }\np,ul,ol,blockquote,dl,table{ margin:1.2em 0; }\nul,ol{ margin-left:2em; }\nul{ list-style:disc; }\nol{ list-style:decimal; }\nli,li p{ margin:10px 0;}\nimg{ max-width:100%;display:block;margin:0 auto 1em; }\nblockquote{ color:#B5B2B1; border-left:3px solid #aaa; padding:1em; }\nstrong,b{font-weight:bold;}\nem,i{font-style:italic;}\ntable{ width:100%;border-collapse:collapse;border-spacing:1px;margin:1em 0;font-size:.9em; }\nth,td{ padding:5px;text-align:left;border:1px solid #aaa; }\nth{ font-weight:bold;background:#5d5d5d; }\n.symbol-link{font-weight:bold;}\n/* header{ border-bottom:1px solid #494756; } */\n.title{ margin:0 0 8px;line-height:1.3;color:#ddd; }\n.meta {color:#5e5c6d;font-size:13px;margin:0 0 .5em; }\na{text-decoration:none; color:#2a4b87;}\n.meta .head { display: inline-block; overflow: hidden}\n.head .h-thumb { width: 30px; height: 30px; margin: 0; padding: 0; border-radius: 50%; float: left;}\n.head .h-content { margin: 0; padding: 0 0 0 9px; float: left;}\n.head .h-name {font-size: 13px; color: #eee; margin: 0;}\n.head .h-time {font-size: 11px; color: #7E829C; margin: 0;line-height: 11px;}\n.small {font-size: 12.5px; display: inline-block; transform: scale(0.9); -webkit-transform: scale(0.9); transform-origin: left; -webkit-transform-origin: left;}\n.smaller {font-size: 12.5px; display: inline-block; transform: scale(0.8); -webkit-transform: scale(0.8); transform-origin: left; -webkit-transform-origin: left;}\n.bt-text {font-size: 12px;margin: 1.5em 0 0 0}\n.bt-text p {margin: 0}\n</style>\n</head>\n<body>\n<div class=\"wrapper\">\n<header>\n<h2 class=\"title\">\nApple Inc. And Buffett: Why He Bought And Why He Holds\n</h2>\n\n<h4 class=\"meta\">\n\n\n2021-08-11 08:34 GMT+8 <a href=https://seekingalpha.com/article/4447893-apple-and-buffett-why-he-bought><strong>Seeking Alpha</strong></a>\n\n\n</h4>\n\n</header>\n<article>\n<div>\n<p>Summary\n\nThis article analyzes Apple under the context of it being the largest holding in the Buffett portfolio.\nThis analysis approaches the purchase under a framework that I call the Buffett’s 10x ...</p>\n\n<a href=\"https://seekingalpha.com/article/4447893-apple-and-buffett-why-he-bought\">Web Link</a>\n\n</div>\n\n\n</article>\n</div>\n</body>\n</html>\n","type":0,"thumbnail":"","relate_stocks":{"AAPL":"苹果"},"source_url":"https://seekingalpha.com/article/4447893-apple-and-buffett-why-he-bought","is_english":true,"share_image_url":"https://static.laohu8.com/e9f99090a1c2ed51c021029395664489","article_id":"1138697562","content_text":"Summary\n\nThis article analyzes Apple under the context of it being the largest holding in the Buffett portfolio.\nThis analysis approaches the purchase under a framework that I call the Buffett’s 10x Pretax Rule.\nAnd this analysis argues that Buffett holds the AAPL shares in the long term for its perpetual growth prospects, offering double-digit return even under its current expensive valuation.\n\nJustin Sullivan/Getty Images News\nThe investment thesis\nIf you are reading this, chances are that you already know that AppleInc. (AAPL) is the largest position in Warren Buffett's Berkshire Hathaway portfolio. When many people wonder if the legend has lost his magic touch, and commented on his blunders with the airline stocks, they forgot that he made more than $100B from AAPL stocks alone! With his concentrated investment style, what he lost on the relatively minor bets such as the airlines is only a footnote.\nThis article analyzes AAPL under the context of it being the largest holding in the Buffett portfolio. This analysis first approaches his entry decision under a framework that I call the Buffett’s 10x Pretax Rule. And then this analysis argues that Buffett holds the AAPL shares in the long term NOT as a technology stock – he had made it clear enough that he does not understand tech companies and will not invest in them. He must be holding AAPL for its perpetual growth prospects. From this perspective, we will see that APPL will still offer double-digit return in the longer run even under its current expensive valuation.\n\nSource: DataRoma\nBuffett’s 10x Pretax Rule\nIf you’re a devout Buffett cultist like this author, you must have noticed or heard that the grand master paid ~10x pretax earnings for many of his largest and best deals. The list is a really long one, ranging from Coca-Cola, American Express, Wells Fargo, Walmart, Burlington Northern, and of course the more recent AAPL purchase and his recent $25B repurchases of BRK.A shares as analyzed in my earlier article.\nThe following chart shows the price history of AAPL and its 10x pretax earning since 2010. Pretax earnings are also referred to as \"EBT\", Earning Before Taxes, in this article. As seen, Buffett made his purchases during 2016-2017 when the price is below or near 10x EBT. I was lucky enough to have made the AAPL purchases at that time myself too.\nBuffet himself also mentioned and discussed the 10x pretax multiple times in his shareholder meetings and Q&A sessions. An example quote is provided below (highlighting was added by me):\nBuffett: “Geico would be valued differently than Gen RE and other insurance businesses because it’s rational to assume a large underwriting profit and significant growth. You cannot say that about many insurance businesses. I would love to buy a new bunch of operating businesses with similar competitive positions to the ones we own now at nine to ten times pretax earnings.”\n\nSource: author based on Seeking Alpha data\nSo are there any reasons fundamental to this 10x pretax rule, or is it only a bunch of pure coincidences? I think it is the former and there are indeed many good reasons for this rule, as listed below.\nFirst, Why pretax?\nOut of all the earning metrics, EPS, operation income, free cash, dividend, etc., why do we favor the pretax earning? I think there are at least two good reasons.\n\nAfter tax earnings do not reflect business fundamentals. Taxes can change from time to time due to factors that have no relevance to business fundamentals, such as tax law changes and capital structure change. Plus there are plenty of ways to lower the actual tax burden of a company.\n\n\nPretax earnings are easier to benchmark, say against bond earnings. The best equity investments are bond like, and when we speak of bond yield, that yield is pretax. So a 10x EBT would provide a 10% pretax earning yield, directly comparable to a 10% yield bond.\n\nSecond, why 10x?\nBesides being a nice and round number, it passes the/my common sense test. A 10x pretax multiple roughly translate into 12 to 15x PE depending on the tax rates, which is not far off from the long term average of stock valuation. Furthermore, if we buy average business at 10x pretax, we already get a 10% pretax return. And if we can do better than buying only average business (like Buffett), paying 10x pretax pretty much guarantees double digit pretax earning. Of course, the 10x here is only for businesses that are conservatively leveraged (say with interest coverage around 10x). The number needs to be adjusted for a highly leveraged business or a business with loads of cash.\nThird, warning and summary\nHere a strong warning is in order. I am NOT suggesting you go out and start buying every/any stock that is below 10x EBT. As investors, we face many risks. Two of the major risks are A) quality risk or value trap, i.e., paying a bargain price for something of horrible quality, and B) valuation risk, i.e., paying too much for something of superb quality. The 10x pretax rule is mainly to avoid the type B risk AFTER the type A risk has been eliminated already.\nSo to summarize, to apply the 10x EBT rule,\n\nthe business should have not existential issue in the long run. However, at the end, this is largely a subjective judgement.\nthe business should have no existential issue in the short run either. This is can be quite reliably and objectively evaluated based on the cash flow and debt coverage.\nIf we paid 10x pretax and bought a business that meets requirement 1 and 2, we will be paying an average price for an average business. Not the best investment ever, but 10% pretax return is not that bad either. If we get a business that offers ANY growth, then we will be buying an above average business at an average price. And we will have a large chance of a double digit return compounding for a long time (if you hold onto to it long enough like Buffett).\n\nAAPL in 2016 and 2017 obviously met all of the above requirements, and it is another textbook illustration of Buffett’s value driven investment success.\nAAPL: why is he still holding it?\nThe next question now is: why is he still holding whenits valuation is not long 10x EBT? As a matter of factor, it is at ~23x EBT now, more than double 10x EBT.\nI am not going to pretend that I know all his considerations. There are so many aspects that needs to be considered with a position of this size - tax liabilities, alternative investment candidates, opportunity cost, et al.\nBut I am pretty certain about one thing – he is NOT holding AAPL as a technology stock, wishing for the next technology breakthrough and double the earning. He had made it so clear that he does not understand tech companies and will not invest in them. He must be holding AAPL for its perpetual autonomous growth – a business that can almost “automatically” grow without the need of too much reinvestment.\nHe said multiple times that there are businesses which, at the end of the day, point to a bunch of depreciated properties and equipment and tell the investors, “these are our profits.” He hates his business.\nAs we will see from the next section, APPL is the exact opposite of those businesses. And due to its ultra-high ROCE and ultra-low requirement of reinvestment to fuel future growth, it will still offer double-digit return in the longer run even under its current expensive valuation.\nPerpetual autonomous growth\nIf you, like this author, are a long-term investor who subscribes to the concepts of owner's earning, perpetual growth rate, and equity bond, then the long-term return is simpler. It is \"simply\" the summation of the owner's earning yield (\"OEY\") and the perpetual growth rate (\"PGR\"), i.e.,\nLonger-Term ROI = OEY + PGR\nBecause in the long term, all fluctuations in valuation are averaged out (all luck at the end even out). And it doesn't really matter how the business uses the earnings (pay out as dividend, retained in the bank account, or repurchase stocks). As long as used sensibly (as AAPL has done in the past), it will be reflected as a return to the business owner.\nOEY is the owner's earnings divided by the entry price. All the complications are in the estimation of the owner's earnings - the real economic earnings of the business, not the nominal accounting earnings. Here as a crude and conservative estimate, I will just use the free cash flow (\"FCF\") as the owner's earnings. It is conservative in the sense that rigorously speaking, the owner's earnings should be free cash flow plus the portion of CAPEx that is used to fuel the growth (i.e., the growth CAPEx). At its current price levels, the OEY is ~3.6% for AAPL (~27.4x price to FCF).\nAgain, the valuation is quite expensive and the OEY is merely 3.6%. But do not be under impressed yet, because there is a second part to the long term return, the part is the created by the PGR, perpetual growth rate. In the long term, the growth rate is:\nPGR = ROCE * Reinvestment Rate\nROCE stands for the return on capital employed. Note that ROCE is different from the return on equity (and more fundamental and important in my view). ROCE considers the return of capital ACTUALLY employed, and therefore provides insight into how much additional capital a business needs to invest in order to earn a given extra amount of income – a key to estimate the PGR. The reinvestment rate is the portion of income the business plows back to fuel further growth.\nSo to estimate the PGR, we need to estimate two things: ROCE and reinvestment rate.\nTo estimate the ROCE of businesses like AAPL, I consider the following items capital actually employed:\n1. Working capital, including payables, receivables, inventory. These are the capitals required for the daily operation of their businesses.\n2. Gross Property, Plant, and Equipment. These are the capitals required to actually conduct business and manufacture their products.\n3. Research and development expenses (an essential expense for a business like AAPL).\nBased on the above considerations, the ROCE of AAPL over the past decade are shown below. As seen, it was able to maintain a respectably high ROCE over the past decade: it used to be 450% early in the decade and still hovers around an average of 150% in recent years since 2016. To put things in perspective, as detailed in myprevious articleforVisa Inc., another autonomous grower that Buffett likes, Visa features a ROCE “only” around 105%.\n\nSource: author and Seeking Alpha.\nNow let’s see the reinvestment part. In recent years, the following is how AAPL has been allocating its operation cash (“OPC”). As seen, AAPL has been using on average ~33% of the OPC as maintenance CAPEx and dividend. So these two “mandatory” have been on average costing only 1/3 of AAPL’s operation cash in recent years. The quotation mark means even though dividend is usually considered an optional cost. But for a stock with AAPL’s status, management probably won’t cut it unless they really have to.\nFor the remaining 2/3, the company does have a choice. It can use it for a variety of things: reinvest to fuel further growth, retain it to strength the balance sheet, pay an extra special dividend, pay down debt, buyback shares, et al. It obviously makes total sense to reinvest all of it to fuel further growth given its 150% ROCE. At this ROCE, $1 reinvested would be fuel $1.5 of additional earning! But the problem is that for businesses at this scale, there are just not that many opportunities to reinvest the earnings. As a result, AAPL has been allocating a part of the remaining earning, on average 70% in recently years, to buy back shares. Such repurchases, besides reflecting the confidence of the management on their own business, again also signals the lack of good reinvestment opportunities.\nBut all things considered, with such spectacular ROCE, AAPL does not need that much reinvestment to grow, as elaborated below.\n\nSource: author and Seeking Alpha.\nWith a 150% ROCE, it means that even if AAPL only reinvests 5% of its earning to expand the capital employed, it could maintain a 7.5% PGR (PGR = ROCE * fraction of earning reinvested = 150% * 5% = 7.5%). As aforementioned, this is a reason that AAPL can afford to use pretty much all the OPC for dividend and share repurchase after covering its maintenance CAPEx.\nNow we have both pieces of the puzzle in place to estimate the long-term return. At its current price levels, the OEY is estimated to be ~3.6%, and the PGR is about 7.5%. So the total return in the long term at current valuation would be a double digit 11% as shown in the chart below. Also as seen, even when ROCE fluctuates somewhat, the fluctuations wouldn’t change the long-term return dramatically.\n\nSource: author.\nConclusion and final thought\nMany of Buffett's largest and best deals are purchased below or around 10x EBT, ranging from Coca-Cola, American Express, Wells Fargo, Walmart, Burlington Northern, and also the more recent AAPL purchase and his $25B repurchases of BRK.A shares.\nThis article analyzes AppleInc.under the context as the largest purchase and also largest holding in the Buffett portfolio. This analysis approaches the purchase under a framework that I call the Buffett’s 10x Pretax Rule. The analysis showed that When Buffett purchased AAPL in 2016 and 2017, it met all the requirements for the 10x pretax rule and represented another textbook illustration of his value driven success.\nThen this article also attempted to answer why he is holding it given the current relatively expensive valuation. He is definitely NOT holding AAPL as a technology stock, wishing for the next technology breakthrough to double the earning. He must be holding AAPL for its perpetual autonomous growth – a business that can almost “automatically” grow without the need of too much reinvestment. From this perspective, the result show that these shares still can offer double-digit return even under its current expensive valuation.\nAnd as a final note before ending this section, this might be the most valuable insight that I’ve learned by studying Warren Buffett’s investment philosophy. The insight really is that I do not need a business with double-digit growth to generate double-digit returns. A reliable business that can offer a stable growth at a boring rate of a few percent (like ~5%) can already provide double-digit returns with good certainty as long as A) they are purchased at a reasonable valuation, and B) they have ROCE sufficiently high so that the growth can be driven by reinvesting a small fraction of the income. In the long run, assuming a growth rate more than 5% percent probably is a dangerous assumption to start with anyway.","news_type":1},"isVote":1,"tweetType":1,"viewCount":130,"commentLimit":10,"likeStatus":false,"favoriteStatus":false,"reportStatus":false,"symbols":[],"verified":2,"subType":0,"readableState":1,"langContent":"EN","currentLanguage":"EN","warmUpFlag":false,"orderFlag":false,"shareable":true,"causeOfNotShareable":"","featuresForAnalytics":[],"commentAndTweetFlag":false,"andRepostAutoSelectedFlag":false,"upFlag":false,"length":4,"xxTargetLangEnum":"ORIG"},"commentList":[],"isCommentEnd":true,"isTiger":false,"isWeiXinMini":false,"url":"/m/post/892191604"}
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