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Apple (AAPL) is in one of its most significant tailspins in its recent history which has seen the stock drop from $705 in September to almost a six-month low of $537 this past week. This plummet has shaved over $100B off of Apple's market capitalization and has the stock fully in bear market territory (~23% decline). Three months ago everyone loved Apple and was clamoring to own it but now investors are fleeing for the exits. The fundamental changes for Apple have been insignificant over this time period and hardly warrant the drop.

Nevertheless, you are nervous. Your modest ten percent holding of Apple has dragged your entire portfolio down more than two percent. I am in a similar situation so I understand the concern. So why not capitulate and move on. Is that really the best course of action? I have combed the major news sources and blogs to try and get a grip on why Apple has suddenly fallen out of favor.

This decline is not simply a fluke as it seems that most media outlets are actively seeking out negative stories on Apple to further propel the spiral. There is even a new story alleging that one of Apple's new retail stores is too loud. Below I will highlight the top three reasons why you might sell Apple and move on if you are that easily shaken. I will additionally refute these reasons and explain why the smart money will stick with Apple.

(Source: Yahoo! Finance)

Apple Has Lost Its Edge

Since Apple effectively ousted Scott Forstall and John Browett in late October many analysts are speculating that Apple is disorganized and in turmoil. Forstall was always a polarizing figure at Apple but had the support of Steve Jobs. Forstall has been reported as stating that there is no "decider" at Apple now that Steve Jobs as passed away. There is no question that this type of management shakeup is uncharacteristic for Apple but these issues have persisted for quite some time at Apple and Cook just took corrective actions to remedy the issues. As I stated in August, Browett was simply not a good fit for Apple as his skillset related to discount retailers rather than luxury retailers.

Apple had missteps under Jobs just like every other company and it will continue to have slipups under Cook; no manager is perfect. Not only did Jobs have his hands on the blueprints for future Apple devices lasting for years but a good portion of his design style has likely rubbed-off on top executives. Jony Ive is still around and will continue to keep Apple products more attractive than any competitors' offerings. Ive has worked for Apple since 1996 and is one of the masterminds behind the minimalistic design of all Apple products and services. With the aforementioned management realignment, Ive will assume a larger role.

Seemingly in the last month investors have decided that Apple will become the next Research in Motion (RIMM) or Microsoft (MSFT) and simply stop innovating. I am a big supporter of Apple and even I will admit that there will be a point at which the company loses its edge. Fortunately that day is still years off. Apple was not just one man and I am confident that it has a strong creative team with a robust pipeline in place.

So no, Apple is not in turmoil and the company is not struggling to attract and retain talent. The stock options awarded to top executives will certainly allow Apple to fill the retail role with a top executive who is a better fit for Apple. Ron Johnson was Apple's former retail chief and he was largely responsible for the creation of the Apple store and its famous customer service. Johnson is currently struggling tremendously as the CEO of JCPenney (JCP) as he has not been able to adapt his luxury store concepts to the discount retailer. I raise this point to show that it is not always important to have the best executive - you need to find the best fit.

The Fiscal Cliff Will Force Further Stock Sales

The US economy is at a pivotal turning point and the decisions made by the new Congress will have far reaching implications for the future of our country. Without action, the taxes paid by most Americans will rise significantly next year and the economy will naturally stall. Apple is impacted by the fiscal cliff more than just about any company for two reasons.

As a luxury retailer that sells premium products, any reduction in discretionary spending will reduce demand. Apple does not sell necessary products so it is easy to surpass buying the newest iPhone for one cycle in favor of building up a "rainy day fund". Apple is insulated to some degree because its products are viewed with such high esteem but it is unavoidable for its growth rate to decline. Fortunately for Apple this will impact all players in the industry and is not unique to the company.

The second reason why Apple is vulnerable to the fiscal cliff is the astounding performance of the stock. If you purchased Apple on January 3rd of this year and have held through today, you are up nearly 34%, despite the recent slump. Investors who have held even longer are very likely sitting on gains in excess of fifty or even one-hundred percent. With concerns that preferential capital gains rates could expire at year-end, it is completely understandable for investors to be jittery and consider lightening their Apple holdings before January.

Furthermore, Apple is rapidly becoming a dividend stock and now yields just shy of two percent. The prospect of treating dividends as ordinary income would fundamentally decrease Apple's value, as it would for all dividend-heavy stocks. While Apple is yielding "only" two percent currently, the company's rich cash stockpile opens the possibility for significant future increases.

The economic and political issues are very serious but are not fundamental issues for investors in the long-term. We will have some kind of resolution to the fiscal cliff in the next fifty days (either a deal gets made or not) and the clarity will help Apple. Right now the uncertainty is far worse than any alternative. It is difficult to fathom both Republicans and Democrats not coming to some kind of deal that will convert the fiscal cliff into a fiscal slope that is much more palatable. As a result, Apple should see a nice rebound once a deal is forged.

Competition Has Finally Caught Apple… This Time

This is one of the funnier arguments as pundits are always so quick to proclaim new products as iPod, iPhone, or iPad killers. This cycle continues ad nauseum and is quite amusing. Even if competitors release products that are better than existing Apple offerings, consumers will stick with Apple due to its high switching costs and brand loyalty. Let's just say that Microsoft did not have hoards of users lined up to purchase its new Surface tablet upon launch.

People point to the iPad Mini rivals that offer products that are comparable at lower prices as evidence that Apple has lost its edge. They say that Steve Jobs would never have launched a seven inch tablet but it is extremely unlikely that the iPad Mini was not in a pre-development form while Jobs was alive. One of Apple's greatest characteristics is that its engineers are not afraid to cannibalize existing products in order to head-off competition. Remember that Apple pursues a completely different strategy from Google (GOOG) and Amazon (AMZN) with respect to hardware. Apple profits primarily from its sizable margins (upward of 40% for the iPad Mini) while Google and Amazon are happy to break even and profit off of the backend.

Apple rarely offers the best technical specs and almost never does it at the lowest cost. Consumers are more than willing to pay-up for Apple's sleek ecosystem that just works. Many authors point to the fact that Samsung is finally outselling Apple as further proof that Apple is trailing. The new Galaxy S3 outsold the old iPhone 4S by 1.8M units in the past quarter which is hardly a fair comparison. Not only are you comparing an old phone to a new one, it is mindboggling that Apple was able to sell so many 4Ss when it was known to be releasing a new phone shortly. I work in a major Northeast market and anecdotally iPhones still account for about 75% of smartphone users I see.

Microsoft was even forced to admit that its new surface tablet only had a "modest start". At this point, it will take a Herculean effort to dethrone either the iPhone or the iPad. The competition has been severely overstated. Even if Apple simply stopped innovating today it would likely be the market leader for years with just simple, incremental upgrades. Of course such a scenario is extremely unlikely. With Ive in a top position, you can be sure that Apple will continue to produce the most desirable technology on the planet.

What's Next?

You will be hearing these same three concerns for at least the rest of 2012 so if you are nervous about Apple you might as well get out now since there is no clear resolution in sight. On the other hand, if you can muster up some resolve and are confident in Apple then you have an extremely attractive opportunity on your hands.

With all of the negatives out of the way, it is time to shine some light on the positive aspects of Apple. Apple is currently trading at multiples unseen since mid-to-late 2011 before it went on its astonishing run in early 2012. The current P/E is 12.4 while the forward P/E is 9.3. Once you extract the substantial "cash+", the forward P/E drops to an approximate 7.4. If you are able to find a company growing at the same rate that also happens to be best of breed in its industry, go ahead and buy it. Until then you need to stick with Apple. The only other companies that I personally follow with lower P/Es are all either struggling financially and/or are in poor industries that face difficulties.

If I have not scared you away from Apple yet, I will present two similar option strategies to capitalize on fear surrounding Apple.

  • Long AAPL; Short November (Monthly) $550 AAPL Calls
  • Sell November (Monthly) $540 AAPL Puts

The puts are currently trading at $6.55 and are currently out of the money by approximately three dollars. This indicates that as long as Apple stays above $536.28 (before transaction costs), the trade is profitable. Selling puts is a great strategy if you are comfortable buying Apple at $540 and you get to keep the $6.55 premium regardless. The ideal scenario would be that Apple stays above $540 as you would make a decent return on your capital for less than one week's work. There is always that possibility that Apple can fall further than $535 but you are provided with a decent margin of safety before the trade loses money.

The covered call has a similar risk profile but has approximately seven dollars of potential upside and the trade yields a loss more easily than selling puts would. Covered call writers want Apple to stagnate then rise close to $550 towards the end of the weak as they will keep the call premium and log decent capital gains. Regardless of your strategy, I believe that now is an excellent time to have long Apple exposure. This will likely be one of those moments that investors look back on in a year and wonder why they did not add to their Apple investment. Hopefully you are not one of those investors.

Source: Just Sell Apple If You Are Nervous

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