Warren Buffett Just Downgraded Apple Stock. Should You Too?

Surprising news just arrived in Omaha, Nebraska. Warren Buffett sold half of his Berkshire Hathawaymonstrous share in Apple (AAPL 1.37%)adding tens of billions of dollars to the company’s cash. At the end of the last quarter, Berkshire Hathaway had $277 billion in cash and equivalents, making it one of — if not this — the world’s largest cash reserves for a single company.

Berkshire’s investment in Apple was worth $84 billion at the end of the second quarter, up from $150 billion a few years ago. What does Buffett plan to do with Berkshire’s money? Why has he become disenchanted with Apple? And should you do the same with your portfolio? Let’s take a closer look and find out.

Stagnation in sales growth

Apple reported financial results on August 1 for the second calendar quarter of 2024. The results have been similar over the past few quarters. Hardware revenue stagnated, with iPhone, iPad, and wearable revenue all declining in the first nine months of Apple’s current fiscal year compared with the previous year. The one bright spot was the Mac, but that was a slight increase in sales.

On the positive side, Apple’s services revenue continues to grow. Revenue from the segment reached $71 billion in the past nine months, up from $63 billion in the same period a year earlier. Services is a higher-margin business for Apple, which comes from App Store fees, advertising, Apple TV and other software it sells to customers. That’s been Apple’s story for a long time. Even though Apple isn’t increasing hardware sales, these new software products will drive growth for the company.

Overall, Apple’s sales haven’t changed in a while. After a boost from the COVID-19 pandemic, revenue has been flat in the past 12 months for several years. In fact, revenue is still down from the peak it reached in late 2022. One big reason is China. The region is important to Apple and currently has a weak consumer economy. Revenue in the first nine months of this fiscal year was $52 billion in China, down from $57.5 billion a year earlier.

AAPL Revenue Data (TTM) by YCharts

Apple’s Services Revenue Future Uncertain

Apple’s services business looks like it’s all sunshine and rainbows, which is driving up margins. But a large chunk of Apple’s services revenue is simply a distribution payment from Google, which is supposed to be the default search engine in Safari. Apple reportedly receives more than $20 billion a year from Alphabet for this distribution deal, which includes profit margins close to 100%. Analysts estimate that this payment could represent 15% of Apple’s consolidated earnings power.

Now, that payment arrangement risks falling apart. A judge just ruled that Google’s default search engine distribution agreements are monopolistic, siding with the U.S. government in its case against Alphabet. That could be bad news for Alphabet, but even worse news for Apple. If it loses that lucrative distribution deal, Apple would lose about 15% of its profits overnight. And that’s coupled with stagnant revenue growth. The one jewel of its business—services—could become a dud within a few years if the courts rule against Apple.

AAPL P/E data by YCharts

Stocks look expensive

Even as Apple’s revenue stagnates and its high-yield Google distribution arm is at risk of implosion, the stock hit a record high late in the second quarter. It’s no wonder Buffett is selling some of his position.

Today, the stock is slightly lower due to the overall market decline. However, it is still trading at a pricey price-to-earnings (P/E) ratio of 31.5. This is significantly higher than S&P500 average for a company with stagnant sales. Buffett likes to buy companies closer to a P/E of 10, which is when he started buying Apple shares eight years ago.

He clearly still likes the business—it’s Berkshire Hathaway’s largest equity holding—but the stock is very expensive at these prices. A low-growth stock with uncertainty around much of its earnings and cash flow (Google’s antitrust case) doesn’t deserve to trade at more than 30 times earnings. Not even Apple. Buffett understands that, which is why he’s trimming his position. He’d rather sit in short-term U.S. Treasuries that pay him a guaranteed 5% interest each year.

If you own Apple stock, that doesn’t mean you should immediately sell your position. But if it’s an above-average position in your portfolio, like Berkshire Hathaway, it may be wise to diversify your holdings with Buffett.

Suzanne Frey, a director at Alphabet, is a member of The Motley Fool’s board of directors. Brett Schafer has positions in Alphabet. The Motley Fool has positions in and recommends Alphabet, Apple, and Berkshire Hathaway. The Motley Fool has a disclosure policy.