Warren Buffett (Trades, Portfolio), the longtime boss of Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) and doyen of value investing, was for many years a skeptic when it came to tech companies. During the dotcom bubble of the late 1990s, while other investors and fund managers were bidding up internet stocks to maddening multiples, Buffett was sticking to what he knew, which were companies that made sense to him and that were producing real cash returns for investors (whether through reinvesting growing profits or paying out healthy dividends).
Recently, however, Buffett seems to have altered course, at least in part. Perhaps the most notable shift in strategy was his decision to invest heavily in Apple Inc. (AAPL, Financial). Indeed, Buffett’s stake in the computer and smartphone juggernaut had ballooned to $50 billion in August.
Does this shift represent a rejection of his value principles? We think not. Let’s discuss why that is the case.
Can growth stocks be value plays?
Benjamin Graham, the father of value investing and originator of modern-day securities analysis, was clearly skeptical of speculative stocks with high valuation multiples. In his book, “The Intelligent Investor,” Graham is quite clear on this point. He argued that a good company may be overvalued, but that a correction can offer an opportunity at a later date, saying that “Some of these issues may prove excellent buys – a few years later, when nobody wants them and they can be had at a small fraction of their true worth.”
That may sound like a repudiation of the growth stock investment strategy, but that is too simplistic a reading. Indeed, Graham did not prima facie reject the idea of buying growth stocks. Rather, they could be attractive given a certain important caveat:Â “The stock of a growing company, if purchasable at a suitable price, is obviously preferable to others.”
In other words, if the price is not astronomical, then a growth opportunity may also present a value opportunity. Given its vast cash hoard, income and dominance of the smartphone market, it is clear Buffett feels Apple falls into this category.
Separating wheat from chaff
So a growth stock, even a tech stock, is not inherently overvalued necessarily. Certainly, many are. That makes separating the wheat from the chaff that much more challenging for an investor.
The challenge is especially difficult when the company is designated as “tech” because of a range of connotations associated with the term. High valuation multiple is one such connotation. But the element that matters most, we would argue, is whether the company is justifying that multiple by showing real earnings growth, or some other growth metric. Top-line growth is popular in many tech stocks, such as Amazon (AMZN, Financial), but even that is sometimes too concrete. Companies such as Netflix (NFLX, Financial) sustain eye-watering multiples thanks to even woolier metrics like user growth on their online platforms.
Perhaps the best explanation of the proper distinction between pure growth and potential value opportunities in tech stocks is offered by Robert Vinall, one of Germany’s foremost value investors:
“A more productive way to think about ‘Tech’ businesses is as ‘viable’ businesses. Yes, this is also a mischaracterisation – not every business started prior to the Internet age is unviable, nor is every Internet-age business immune to disruption – but it is a nudge to be more open to them and removes the idea that they are just one segment of the economy, that can be easily dismissed as ‘too difficult’. Who would not want to invest in viable as opposed to unviable businesses?”
In other words, the most important distinction among tech companies is that some have the power to genuinely become earnings machines (if they are not yet already), while others have tenuous business models with limited hope of growing into outsized valuations.
Is Apple a value stock?
Now that we understand the distinction among tech stocks, we must now come to the real question: Is Apple a value opportunity like Buffett says?
We have mixed feelings on this point. Apple is clearly an excellent business with a huge trove of cash and room to grow in all manner of directions. It has some of the hallmarks of a growth stock, including tremendous top-line growth over the past decade.
Unsurprisingly, that rapid growth on both the top and bottom lines has seen considerable share price growth. Subsequent growth in its valuation multiples give us some pause.
On other metrics, however, Apple actually looks quite attractive. Surprisingly, despite tremendous growth since the end of the Great Recession, the ratio of the company’s share price to its tangible book value has still not hit its pre-recession highs.
Ultimately, among the so-called FAANG stocks of the high-priced, zippy 21st century tech sector, Apple is probably the most fairly valued.
Verdict
Despite Buffett’s big play on Apple, we hesitate to call it a true value opportunity all the same. It probably has room to grow over the long term, but we also caution that its high share price may suffer in the event of a significant correction.
Apple is a great company and could be a great investment. But it may be just a tad richly priced for a serious value player. At the same time, we are loath to argue with the Oracle of Omaha.
Invest wisely and with caution!
Disclosure: No positions.
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