How To Own Apple At 12x PE (Or Free) Through Berkshire Hathaway

Summary

No matter how much you love Apple’s business fundamentals, its elevated PE could be off-putting or even concerning.

This article shows a backdoor to own Apple shares at a heavily discounted valuation or even for free through Berkshire Hathaway shares.

This opportunity is created by the discrepancies between accounting earnings and economic earnings, or true owners’ earnings.

Justin Sullivan/Getty Images News The investment thesis

If you have been a shareholder of Apple ( AAPL ) in the past years, congratulations! However, even for shareholders like ourselves who are committed for the long term, its current elevated PE (30+) could be off-putting or even concerning.

This article provides several good news to relieve some of your concerns. Firstly, the commonly quoted PE is based on AAPL’s accounting earnings, which are an underestimate of its true economic earnings. And you will see in this article that if you consider this discrepancy, its valuation is not as high as it seems on the surface. And secondly, and more importantly, this article will also show you a backdoor to own AAPL shares through Berkshire Hathaway ( BRK.B ) shares at even lower valuations. BRK is quite a complicated conglomerate and its accounting earnings and true economic earnings differ even more dramatically.

As you will see, such discrepancies provide a backdoor to own AAPL shares at a heavily discounted price. The exact discount depends on how you value BRK’s operating business segments, and ranges from owning AAPL at 12x PE to owning it for free. AAPL’s accounting EPS and owners’ earnings

The concept of owner earnings, to my best knowledge, was first detailed by Warren Buffett in Berkshire Hathaway’s annual report in 1986. Buffett defined owner earnings as follows (emphasis 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). To put it differently, the CapEx expenses for a business are the sum of two parts: the maintenance CapEx and growth CapEx. Maintenance CapEx is part C) that Buffet mentioned above. It is the mandatory part to keep the business running and maintain its long-term competitiveness. And the growth part is the optional part. The growth part should actually be considered part of the owners’ earnings because it can be returned to the owners if the owners decide not to grow the business anymore – a key insight that investors like Buffett have been promoting for decades.

Dissecting the maintenance CapEx and growth CapEx is, therefore, crucial to understanding the true economic earnings. However, as mentioned by Buffett, the 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.

Under this background, the following table shows my best guess of AAPL’s maintenance CapEx, growth CapEx, and owners’ earnings. This analysis is performed by Bruce Greenwald’s method. Readers interested in more details could take a look at my earlier article and are highly recommended to take a look at Greenwald’s book entitled Value Investing . As shown, AAPL’s owners’ earnings are about $5.8 per share, which is higher than both its free cash flow and its accounting EPS. The reason is that the part of the growth CapEx should not be considered an expense to the business.

So you can see here, by interpreting the true economic earnings, AAPL’s valuation is not as high as it seems on the surface already. And we will see next that its valuation is further discounted when owned through BRK. Source: Author based on Seeking Alpha data True cost of owning AAPL through BRK

The following table shows a snapshot of the current financials of BRK. The business boasts a market capitalization of 649 billion U.S. dollars as of this writing (or $295 per share). Out of the $649B market cap, $293 billion is invested in an equity portfolio and $149 […]

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