Apple Is No Longer A 'Don't Buy'

| About: Apple Inc. (AAPL)

By now, pretty much anyone with even a mild interest in investing knows about the horrific performance of Apple's (NASDAQ:AAPL) stock after the most recent earnings release. I suspect the nearly 40% slide from its all-time high has caused and will continue to cause much reflection among many Apple shareholders, both professional and so-called retail investors. My hunch is that the apparent cheapness of the stock based on commonly used valuation metrics versus the relentless price declines of the stock has caused considerable unease among fundamentals-based investors, and perhaps even shattered some investors' confidence in picking stocks.

If you are an Apple shareholder engrossed in reflection, I think some of my Apple-focused articles from last fall may be of interest. You can find them here. Additionally, the following sections from Chapter 9 of my book, "The 5 Fundamentals of Building a Retirement Portfolio," may be of interest as part of the reflection process on what exactly happened to Apple's stock over the past several months and why it is that so many investors didn't see it coming: (1) Confirmation Bias and the Endowment Effect, (2) Anchoring, (3) Trusting Analysts, and (4) Random Musings.

In addition to reflecting on the past, Apple investors should also be spending considerable time assessing future growth prospects for the company, as that will have a major influence on the stock's valuation going forward. Furthermore, investors buying at today's valuations, hoping for multiple expansion, need to seriously consider not only Apple's future growth prospects but also what the shareholder base will look like going forward (value investors versus growth investors). If the shareholder base is indeed changing toward value investors (as many are hypothesizing), then fast-paced multiple expansion is something for which investors should not hold their breath.

Moreover, when thinking about the immediate future, investors should keep the following two things in mind:

1. At some point, Apple's stock will rally strongly, if only because stocks often bounce sharply off oversold conditions. When that time comes, keep in mind that overhead supply will be a headwind for any longer-lasting rally. I suspect the emotional pain and confusion among many Apple shareholders has been so great during this decline (magnified by the fact that the broader market has been rising during Apple's sell-off) that there will be many shares available for sale on the next rally. Think about all the people who bought the stock during the decline, only to immediately experience large unrealized losses. I think there will be plenty of people who will breathe a sigh of relief if they have the opportunity to get out even on their more recently purchased shares. There is a long history in the stock market of that type of behavior occurring, and Apple will likely be no exception.

2. Investors may be wondering what signs to look for that the stock is bottoming. While a specific catalyst, such as a massive dividend hike, could certainly help to put an immediate floor in the stock price, there is something else that could help investors gauge when the relentless declines are nearing an end: relative performance to the S&P 500 (NYSEARCA:SPY) and Nasdaq 100 (NASDAQ:QQQ). When Apple begins to stop underperforming both indices over a several day period, investors will likely feel more comfortable initiating larger long positions. On many occasions, I have successfully used relative performance during broader-market declines as a way of identifying stocks that will rise sharply once the major indices stop falling. If there is a pullback in the S&P 500 and the Nasdaq 100 in the near future, it will provide a great opportunity for Apple investors to gauge the health of the stock and possibly identify a turning point before everyone else does.

On a final note, remember that stocks often top when the news and fundamentals never looked better. Hype, especially around a company as popular as Apple, can easily reach extremes that magnify the cognitive biases of investors (such as the ones mentioned in Chapter 9 of my aforementioned book) and cause people to chase returns in the stock market. The crescendo of hype surrounding Apple is something investors will no doubt see again in other stocks and perhaps even see in the major market indices. Reflecting on your experience with Apple can help to better prepare you for the next encounter you will have with hype and hysteria in the stock market.

In the meantime, I am now adding Apple to my list of stocks to trade from the long side. This means that on any given day and at any given time, I may initiate a long position in Apple. I think Apple is fairly valued, but I also recognize that strong declines often take stocks well below fair value. Additionally, I am concerned that a broader-market pullback could put continued downward pressure on Apple's stock. But if you are an investor with the capital to purchase at least 100 shares of Apple, the ability to sell covered calls will now, in my opinion, tilt the odds in your favor that you can, over time, stem losses on any positions entered in the lower $400s should the stock continue downward. As a result of this, Apple is now a stock that no longer deserves to be labeled a "Don't Buy" and instead can be added to a watch list of stocks to buy. Apple is still not a resounding "Buy" in my book, but it is now certainly worth a look.

To summarize my take on Apple, I now think investors can trade it from the long side because, with the ability to sell covered calls, I think it will be difficult to lose money over time. When the stock was trading in the $500 to $700 range, the downside risks were too great relative to the premiums that could be collected on covered calls. I now think that the downside risks are not greater than the premiums that can be collected over a period of many months, should one feel the need to sell covered calls as a hedge against a long stock position. At the end of the day, investors will buy something either because they believe the odds are favorable that they won't lose money or because they believe the odds are favorable that they will make money. People express this in different ways, such as using valuations to argue the stock is cheap or arguing that the market doesn't yet appreciate certain products that are in the pipeline. But ultimately, people will invest if they think the risk to their principal is low and the possibility of making money is high. I believe that is now the case when trading Apple in lots of 100 shares (enough to sell covered calls against the position).

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in AAPL over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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