Warren Buffett is considered one of the greatest investors in American history due to his track record with Berkshire Hathaway (NYSE: BRK.A) (NYSE: BRK.B). Specifically, Berkshire stock has compounded at roughly 19.8% annually since Buffett took control of the company in 1965, nearly doubling the performance of the S&P 500.

In recent years, one of the most widely discussed aspects of his business has been its sizable stake in Apple (NASDAQ: AAPL). Berkshire began buying shares in 2016. Whether the original purchase was made by Buffett or his understudies is unknown, but Buffett likely controlled the position as it grew in size over the years, and he is likely responsible for trimming the position in recent quarters.

• Q4 2023: Apple accounted for 49% of Berkshire Hathaway's stock portfolio.

• Q1 2024: Apple accounted for 40% of Berkshire Hathaway's stock portfolio.

• Q2 2024: Apple accounted for 30% of Berkshire Hathaway's stock portfolio.

In May 2023, Buffett said, "Apple is different than the other businesses we own. It just happens to be a better business." That statement is seemingly at odds with the recent selling spree. CNBC estimates that Berkshire's stake in Apple declined to 400 million shares in June 2024, a 55% reduction from 905 million shares in December 2023.

However, Buffett's conviction in another megacap company has not wavered. He has repurchased shares of Berkshire Hathaway stock in each of the last three quarters, spending a collective $5 billion on buybacks. The message is clear: Buffett believes Berkshire is undervalued.

1. Apple

Apple has cultivated immense pricing power by pairing trendy hardware with proprietary software and services, creating a closed ecosystem that other manufacturers cannot replicate. Indeed, the average iPhone sells for three times more than the average Android smartphone. Apple has a strong presence in smartphones, personal computers, tablets, and smartwatches, and the company also operates the leading mobile app store and it has one of the fastest-growing advertising businesses in the U.S.

Apple reported lackluster financial results in the June quarter, despite beating expectations on the top and bottom lines. Revenue increased 4.8% to $85.8 billion and GAAP net income rose 7.6% to $21.4 billion. There were a few highlights. The company continued to repurchase stock, so earnings per share increased 11%. Apple also reported 14% sales growth in services, which come with much higher margins than its hardware products.

However, sales in China fell 6% and operating income slipped 10% during the quarter, as promotions failed to overcome waning demand for iPhones. Indeed, IDC estimates that quarterly iPhone shipments in China declined 3%, despite an acceleration in the broader market. As a result, Apple lost its spot among top five smartphone companies in the region, while local competitors like Huawei and Xiaomi gained share. That trend is problematic because China accounted for 19% of total revenue in fiscal 2023 (ended September 2023).

Going forward, Wall Street expects Apple to grow earnings per share at 10% annually through fiscal 2025. That makes its current valuation of 33.5 times earnings look outrageously expensive. I say that because it gives Apple a PEG ratio of 3.4, well above the three-year average of 2.5. That may explain why Buffett has aggressively sold Apple in recent quarters, and it also leaves room for continued selling in future quarters.

2. Berkshire Hathaway

Berkshire Hathaway owns subsidiaries in a diverse range of industries, including insurance, railroads, energy, utilities, manufacturing, and retail. The core insurance business generates investable cash with which Warren Buffett has earned great returns. As evidence, Berkshire's book value per share — a good measure for changes in intrinsic value — compounded at 12% annually over the last five years, nearly keeping pace with the 13.1% gain in the S&P 500.

Berkshire has another important quality in its resilience. Its subsidiaries have not only been hand selected by Buffett, a consummate investor with a knack for identifying competitively advantaged businesses, but also the diverse nature of those subsidiaries means Berkshire is not overly reliant on a single sector or industry. That has helped Berkshire outperform the S&P 500 during difficult market environments, as shown in the chart below.

Bear Market Start Date

S&P 500 Maximum Decline

Berkshire Hathaway Maximum Decline

March 2000

(49%)

(24%)

October 2007

(57%)

(54%)

February 2020

(34%)

(30%)

January 2022

(25%)

(27%)

Average

(41%)

(34%)

Data source: Yardeni Research, Ycharts.

Berkshire reported reasonably good financial results in the June quarter. Revenue rose 1.2% to $93.7 billion and operating earnings increased 16% to $11.6 billion. The shining star was the insurance segment, where operating earnings from underwriting and fixed-income investments climbed 56%. Meanwhile, earnings generally declined across other segments.

As a caveat, GAAP net income dropped 16% to $30.3 billion during the quarter. However, Buffett has cautioned investors to ignore that figure because it includes gains and losses (both realized and unrealized) on stocks. In the June quarter, Berkshire recorded $28 billion in unrealized losses versus $24 billion in unrealized gains in the same quarter last year. That discrepancy explains the decline in GAAP earnings.

Going forward, Wall Street expects Berkshire to grow operating earnings at 12% annually over the next three years. That makes the current valuation of 22 times operating earnings look a little expensive, though Buffett clearly believes the stock is undervalued. "With our present mix of businesses, Berkshire should do a bit better than the average American corporation and, more important, should also operate with materially less risk of permanent loss of capital," Buffett wrote in his most recent shareholder letter.

Investors looking to strengthen their portfolio with a defensive stock should consider buying a small position in Berkshire Hathaway today.

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Trevor Jennewine has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Apple and Berkshire Hathaway. The Motley Fool has a disclosure policy.

Warren Buffett Is Selling Apple Stock and Buying This Magnificent Megacap Stock Instead was originally published by The Motley Fool