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Why did Berkshire Hathaway buy Apple?

Yesterday, Warren Buffett’s Berkshire Hathaway (NYSE: BRK/B) disclosed a $1 billion stake in Apple (NASDAQ: AAPL). As typically happens when Berkshire makes such a new disclosure, this sent the stock rallying by 4%. It is an interesting move given Buffett’s long-held stance against investing in information technology companies. So the question is, why did Berkshire make this investment?

Well, putting aside the high quality of Apple’s smartphone business and broader ecosystem, we believe a primary reason for Berkshire making the acquisition was Apple’s implied “margin of safety”. The concept of margin of safety can be read about here, but in summary, it is the idea of buying one dollar for fifty cents. Then even if you are wrong about the dollar, you still probably won’t lose money because you have only paid fifty cents.

You see, at $90/share –  price of Apple’s shares prior to the Berkshire announcement, the market was implying a pretty draconian future profit trajectory, as shown below. That is, to break-even on your investment at $90/share, Apple needed only deliver future profit growth of around negative 5% per annum. The market was saying: Apple will be in structural decline forever.

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We thought this market-implied expectation was unreasonably conservative. Apple customers cannot live without their iPhones and are unlikely to switch to a new ecosystem, in our view. Yes, the replacement cycle might be expanding slightly; and yes, average-selling-prices may come under pressure (though this will be offset by an increased total addressable market). But to believe Apple will shrink by more than 5% every year was simply not credible, in our view. Indeed, services revenues (iTunes, Apple TV, Apple Pay, Apps) already account for 10% of total revenue – and are growing at a rate of more than 20% per annum.

Buying with a margin of safety is by far the most important aspect of investing. With Montaka’s investment in Apple, like Berkshire’s, we know that if Apple simply maintains its current level of earnings and never grows again, there is more than 40% upside in the stock. This is a nice position to be in, on behalf of our clients.

Montaka owns shares in Apple.

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Andrew Macken is a Portfolio Manager with Montgomery Global Investment Management. To learn more about Montaka, please call +612 7202 0100.

Our Montaka Long Only funds strive to act as a core, high conviction, global portfolio holding. Consistent with the long portfolios in our Montaka Variable Net funds, this offering is focused on owning the world’s high quality, undervalued businesses – and cash when appropriate – to outperform its benchmark.

Our Montaka Active Extension funds strive for maximised return over the long-term. Owning the Montaka Variable Net long portfolio typically scaled up to approximately 130 percent - and the Montaka Variable Net short portfolio typically scaled down to approximately 30 percent – this these funds results in a net market exposure of approximately 100 percent most of the time.

Our Montaka variable net funds strive for significant downside protection – but with minimal upside reduction. Focused on owning the world’s great and growing businesses when they are undervalued, while managing a portfolio of short positions in businesses that are deteriorating, misperceived, and overvalued, this these funds are our flagship long-short.

Our
Funds

Our Funds

Our Montaka Long Only funds strive to act as a core, high conviction, global portfolio holding. Consistent with the long portfolios in our Montaka Variable Net funds, this offering is focused on owning the world’s high quality, undervalued businesses – and cash when appropriate – to outperform its benchmark.

Our Montaka Active Extension funds strive for maximised return over the long-term. Owning the Montaka Variable Net long portfolio typically scaled up to approximately 130 percent - and the Montaka Variable Net short portfolio typically scaled down to approximately 30 percent – this these funds results in a net market exposure of approximately 100 percent most of the time.

Our Montaka variable net funds strive for significant downside protection – but with minimal upside reduction. Focused on owning the world’s great and growing businesses when they are undervalued, while managing a portfolio of short positions in businesses that are deteriorating, misperceived, and overvalued, this these funds are our flagship long-short.