Warren Buffett built Berkshire Hathaway into one of the largest companies in the world through intelligent acquisitions and prudent investments.

After famously eschewing technology stocks for years, Berkshire surprised Wall Street in 2016 when it reported a stake in Apple (NASDAQ: AAPL). Even more surprising were the subsequent share purchases that eventually made Apple its largest holding.

Last year, Buffett referred to Apple as being a “better business” than any other Berkshire owned, but great businesses are not necessarily smart investments. Berkshire sold 389 million shares of Apple in the second quarter, cutting its stake in half, and the company started a small position in the lesser-known Ulta Beauty (NASDAQ: ULTA).

To be clear, Berkshire still has 30% of its stock portfolio invested in Apple, but that represents a substantial reduction from 51% in the same quarter last year. Also noteworthy, Berkshire has allocated less than 1% of its portfolio to Ulta, but its novelty sets it apart from long-standing positions.

Here’s what investors should know about these stocks.

1. Apple

Apple reported solid financial results in the third quarter of fiscal 2024 (ended June 29). The company not only beat overall sales and earnings estimates, but also its sales exceeded expectations across every major product category except Macs. Revenue increased 5% to $85.8 billion, gross profit margin expanded 174 basis points, and GAAP net income increased 11% to $1.40 per diluted share.

Looking ahead, Apple is well positioned to maintain similar momentum. The company has a strong presence in several consumer electronics markets, including personal computers and smartphones. It also has a strong presence in several service verticals. Apple has one of the fastest-growing advertising businesses and it operates the leading mobile app store. Last year, the App Store earned more than twice as much revenue as Alphabet‘s Google Play Store.

However, Apple is also facing several headwinds. First, the Digital Markets Act in Europe forced the company to support third-party app stores on its devices, which could erode its dominance in the space. Second, Apple has lost so much smartphone share in China (its third largest market) that it no longer ranks among the top five vendors. Third, iPhones account for 45% of total revenue, but the company has yet to eclipse the iPhone sales record set in the first quarter of 2022.

Building on that, Apple possesses tremendous brand authority in consumer electronics, but the company has not launched a new viral product since AirPods in 2017. If that continues, Apple will struggle to exceed mid-single digit sales growth. Earnings may grow faster because the company has historically spent heavily on stock buybacks. But earnings growth that is largely dependent on share repurchases is a sign of a company with limited prospects.

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Nothing I’ve mentioned so far is a deal-breaker, per se. The real problem lies in the disconnect between Apple’s growth prospects and its current valuation. Wall Street expects earnings to grow at 8.6% annually over the next three years, which makes its valuation of 33.5 times earnings look outrageous. Those figures give a PEG ratio of 3.9, a substantial premium to three-year average of 2.6. The sky-high valuation may explain why Warren Buffett slashed his stake in Apple.

2. Ulta Beauty

Ulta operates more than 1,400 stores across the United States, where it sells about 25,000 products spanning mass-market to high-end items from approximately 600 brands. Over the last few years, Ulta has secured a leadership position among U.S. beauty retailers due to store openings, effective marketing, compelling loyalty perks, and investments in e-commerce.

Ulta reported disappointing financial results in the second quarter. Revenue increased less than 1% to $2.6 billion, and same-store sales actually declined 1%. Meanwhile, gross margin contracted 100 basis points, and GAAP earnings declined 11% to $5.30 per diluted share. Management also lowered its full-year outlook, such that evenue and earnings are forecasted to decline 1% and 11%, respectively.

In a recent note, Morningstar analyst David Swartz attributed Ulta’s disappointing performance and guidance to competitive pressure, primarily arising from the rapid expansion of Sephora stores within Kohl’s locations. But he thinks the company will turn things around. “We forecast Ulta will expand its store base by about 20% over the next 10 years while achieving same-store sales growth of about 4%,” he wrote.

Ulta is undoubtedly facing headwinds, but the stock is priced more reasonably than Apple. Wall Street expects earnings to increase at 9% annually over the next three years, which makes the current valuation of 15 times earnings seem fair. Those figures give a PEG ratio of 1.6, which is a slight premium to the three-year average of 1.5.

I think patient investors can follow Berkshire’s lead and buy a small position in Ulta stock today. But small is the key word. I would start with no more than 1% of my portfolio and build my position opportunistically during pullbacks. But investors should bear in mind that Ulta has failed to outperform the S&P 500 over the last three- and five-year periods.

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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Trevor Jennewine has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Alphabet, Apple, Berkshire Hathaway, and Ulta Beauty. The Motley Fool has a disclosure policy.

Warren Buffett Is Selling Apple Stock and Buying This Little-Known Stock Instead was originally published by The Motley Fool