Apple's (the Stock) Best Days May be Behind It - Try Thoratec Instead

Today's first topic is Steve Jobs, Apple and AAPL.

Steve Jobs, of course, is the man at the head of the company. Apple is the company itself. And AAPL is the stock.

They are three separate entities. But investors often make the mistake of confusing them, and that can be dangerous.

For example, the media in recent weeks have focused on Steve Jobs and his health (first there was pancreatic cancer and now there's an unspecified "hormone imbalance"), and worried about the effect on the company should Steve's health problems force him to step down. Others have wondered how much transparency there should be about a CEO's health in the first place, bringing into play the issue of privacy. Still others (typically members of the cult of Apple) have said we should ignore the issue and just have faith that Steve, treated by the best doctors money can buy, will recover and Apple will continue to make "insanely great" products.

Me, I wish him a speedy recovery. After all, he and I (and Bill Gates as well) were all born in the same year, and I hope all three of us have many more productive decades on this side of the grass.

But I'm not making the mistake of thinking that if Steve returns to good health AAPL will continue to be a fine investment.

As to the health of the company, I'm acutely interested. I've been a devoted Mac user since 1987. The Cabot office is 68% Mac-based, my home is totally Mac-based, and I love my iPhone, which currently holds 2,978 songs, 456 photos and a couple videos.

Also, I've attended every East Coast Macworld (2005 was the last). At one early show I even won a raffle for a whopping 1MB of RAM! And I followed Tuesday's Macworld keynote speech online with great interest, happy to see the new features in iLife as well as the new pricing structure and removal of copy-prevention measures for songs in iTunes ... but disappointed in the lack of hardware improvements.

Furthermore, we at Cabot have made great profits by investing in AAPL several times over the decades, most recently taking advantage of the iMac boom (1998-1999) and the iTunes store boom (2003-2007).

But I'm not letting my love of Apple products and services or our previous profits in the stock get in the way of my judgment as an investor. And that judgment is simply this:

AAPL's best days as an investment are over. In fact, APPL is likely to underperform the market in the years ahead. And here's why.

AAPL--the stock--reached the point of peak perception at the end of 2007 when the iPhone was the hottest product of the holiday season and the stock topped out at 203 per share. At the same time, the stock's relative performance (RP) line--which measures the performance of the stock relative to the broad market--topped out as well. Yes, the RP line did return to the same level in May, July and August of 2008, but to chart-savvy technicians, that long top only served to accentuate the message that AAPL's positive momentum had ended. (Note the continuing distinction between Apple and AAPL.)

Since then, competitors--most notably Research in Motion (RIMM)--have embraced the idea of the touch-screen phone, though none has executed it as elegantly as Apple. More importantly, the growth rates of both Apple's revenues and earnings are now decelerating. Finally, I note that at the end of the second quarter, AAPL was owned by a whopping 885 mutual funds ... all of which are now potential sellers.

Now, none of these factors, individually, is the kiss of death, but when I see them all together, I conclude that it's highly likely that the stock's best days are over. Not that it will never reach new highs ... simply that there are far better growth investments available now.

Here's the logic.

Remember, what makes a stock go up is the improving perception, by an increasing number of investors (especially institutional investors), of the company's earnings power. Back in 2003, when AAPL was trading at a split-adjusted 6 and the company announced the launch of the iTunes Music Store, critics carped that the prices for songs were too high, or that not enough music labels would sign on or that the copy-protection scheme was too limiting. But they were all wrong, and as their perceptions improved about the ability of the iTunes Music Store (now called simply the iTunes Store) to earn lots of money, more people--both individuals and institutions-- became buyers of AAPL. Their buying made the stock go up.

Equally important, more people came to love Apple, for its witty TV ads, for its beautiful and functional stores, and for its elegant products, which have brought easy-to-use technology to the masses. And as more individuals bought the stock, and more professionals bought the stock, AAPL went up, and up, and up. (The gain from the 2003 low to the 2007 high was 3,090%.) But at some point, every company reaches a point of peak perception, a point where the greatest number of people love it, and that's the point at which the stock tops out.

For years, my father's favorite example of this phenomenon was International Business Machines (IBM), which stopped outperforming the market in 1984 (the year Apple launched the Macintosh with its famous "1984" television commercial during the Super Bowl). IBM, of course, was so respected that there was a business axiom, "No one ever got fired for buying IBM."

Before that he'd seen Eastman Kodak (EK) stop beating the market way back in 1973. That was far before digital photography built the company's coffin; the stock simply collapsed after perception peaked.

More recently, I've seen other stocks follow the same chart pattern. Cisco (CSCO), Dell (DELL), Home Depot (HD) and Microsoft (MSFT) all have RP lines that peaked at the end of 1999. Remember the perception back then? These companies and their stocks were loved! The future was going to be great! And as a result, their stocks were trading at high valuations. But when the future turned out to be not as good as expected, the stocks sold off. Despite the fact that all four are still great companies and still growing, their stocks are dramatically lower.

• Cisco (CSCO) is now more than twice the size it was in 2000, but its stock is off 79%.
• Dell (DELL) is now more than twice the size it was in 2000, but its stock is off 82%.
• Home Depot (HD) is now more than twice the size it was in 2000, but its stock is off 66%.
• Microsoft (MSFT) is now more than twice the size it was in 2000, but its stock is off 63%.

Now, I'm not saying that AAPL is going to collapse from here; it may well rally if we get a supportive market. After all, it's already off 55% from its December 2007 high. I'm just saying there's no longer a good reason to own the stock. I'm saying that Apple, which Fortune magazine named the most admired company in the United States in 2008, will now slowly become less-loved, and as a result, the stock will no longer be an outperformer, despite the fact that the company continues to grow sales and earnings.

Investors who bought in the past couple years and are sitting on losing positions will eventually get tired of holding a loser and they'll sell, putting pressure on the stock. Growth fund managers will slowly sell it from their portfolios, while managers who value stability will buy it ... but only on dips. And AAPL's RP peak will fade into history.

At the same time, sales and earnings will keep growing, but they'll be growing more slowly. After all, Apple now brings in $32 billion a year, and increased size eventually translates into slower growth.

And it could get worse. Consider what will happen if the current slowdown in consumer spending--driven by a trend toward reduced credit--continues. Apple's rate of growth could slow further. Or consider what could happen if cash-strapped governments decide that taxing Internet purchases (like iTunes products) will help them meet their budgets. That would be another bite out of the Apple. Admittedly, these things are only hypothetical--but so is Steve Jobs' return to health.

The most important thing for an investor in growth stocks to remember is that the market is always looking ahead. Yesterday's news is worth nothing; it's next month's news--and the news that's expected six months from now--that matters. And the actions of the stock every day (particularly a heavily traded stock like AAPL) reflect all the various opinions and perceptions about that future, all the time.

Today, while the market has rallied for six week, AAPL's chart is still under pressure; the stock has failed to better its December high. And buying volume is tepid. Combined with slowing fundamentals and an awareness of public sentiment, it reinforces my conclusion that the point of peak perception has likely passed for AAPL.

Your job now--and ours--is to find the next Apple ... or at least the next hot stock. So how do you find a hot stock? Watch charts, of course, and pay more attention when you find a young unknown company that's growing fast.

In 2006, Crocs (CROX) was the ticket. People thought their shoes were funny looking, but they sold like hotcakes, profit margins were excellent considering the industry, and as perceptions improved, the stock doubled in its first year.

In 2007, First Solar (FSLR) was a huge winner. Virtually unknown at the start of the year with just 50 mutual fund owners (and in a relatively tiny industry), its screaming growth and a public eager to embrace alternative energy spurred the stock to a gain of 850% in the year.

2008, of course, was a bust except for a few commodity-related stocks in the spring. We latched on to Continental Resources (CLR), for example, for a big gain. While the year was enormously educational, I'm glad it's gone.

Now I have great expectations for 2009, and I'm confident the best performers will once again be stocks of companies that are not well loved and that are mostly unknown!

In recent issues I've recommended several medical companies that are focused on genetic science, and I still think highly of them. Growth trends are very good, and the charts tell us investors are slowly discovering these companies and getting on board.

And today I want to give you another name in the medical field.

It's Thoratec (THOR), and it was last mentioned here on December 11, when it was trading at 28. Today it's just a little higher, so it hasn't gotten away. But the stock's main trend is up, and thus the odds are very good that the stock will break out above its recent high of 33 before long (as long as the market cooperates).

The company's business is artificial hearts and heart pumps, a business where demand is driven by unstoppable demographic forces. The stock was featured in Cabot Top Ten Report on December 22, and here's some of what editor Michael Cintolo wrote:

"For heart patients awaiting transplants, Thoratec's HeartMate ventricular assist pumps are a literal lifesaver, helping one chamber of the heart pump enough blood until a donor is found. The big buzz now is that patients too ill for transplants have a significantly higher chance of long-term survival (without suffering damaging strokes) when they use Thoratec's HeartMate II rather than the older HeartMate XVE. The company is waiting for FDA approval for this new usage, and investors are anticipating that it will be received. In the meantime, Thoratec has replaced Dun & Bradstreet in the S&P MidCap 400 Index and UBS has picked up coverage of its stock. Everything seems to be breaking Thoratec's way."

Disclosure: None

Comments

[User 332328:]

Well said, and it's good to see you posting here. Everybody loves a stock that has had a good run, it seems... even if the chances of another similar run are essentially zero. I still love the company, and I've held the stock since 1983, but I'm down to a token position and quite comfortable with that.

Jan 13 06:37 AM

[Gregory Pepin:]

Hello
your article is very interesting but you missed some element concerning Apple :
- Cash availability : Apple has tons of cash and created a cash machine with each of their business
- Potential growth in each market share : Apple has a huge market share upside potential in each sector they are (except the Ipod even if you could consider the Ipod Touch as a new source of growth
- Potential new product upside
- Profit Margin : Apple is provider premium product that offers premium margin whereas company you gave are company that had organic growth after and lower margin...

Jan 13 06:51 AM

[Roger Knights:]

My ten-year target for APL is 1000. The company is now out of favor with institutional holders--i.e., it's more undervalued than overvalued. Earnings surprises are likely to be on the upside. We'll see how it does next week.

Jan 13 07:33 AM

[Roger Knights:]

PS: I think the essential flaw in this article is its assumption that, if a stock has ever lost its status as a favorite, it becomes "a loser" thenceforward. One only needs to make that assumption plain to see how indefensible it is. One could surely list stocks that have risen to a peak, fallen out of favor, and then risen to greater heights. It's not one-way street. Listing stocks that have fallen from a bubble-peak and not recovered is a weak argument.

I suspect however that the author's perception of the stock, as having had its run, is conventional wisdom on Wall Street--which means that buying AAPL is a good contrarian play.

Jan 13 07:45 AM

[User 336307:]

This author is very one-dimensional in his thinking.

Here are three reasons why...

He assumes Apple has no other large expansion areas. Hello! One word.... CHINA. A small country with 1 billion iPhone-hungry new users. That's where an iPhone Nano will show up first.

Apple has a lot of innovation left in them.

Steve Jobs is not the only person at Apple.

The author mentions crox. Look where it is today!

I rest my case.

Jan 13 08:02 AM

[pondside:]

Apple's earnings and revenues are growing very well lately, but this growth has been masked by their accounting. The iPhone business is accounted for on a 24 month basis - the revenue for an iPhone sold today trickles in over the next 24 months. So the very strong iPhone growth will only slowly appear in Apple's revenues and earnings. Check out their non-GAAP earnings as well as their deferred revenues to verify this for yourself, and then you will understand why Apple is still a growth story.

Jan 13 08:23 AM

[strict9:]

- China and Japan are so far ahead of us in terms of cell phone technology it's ridiculous. They have no hunger at all for the iPhone, which lacks major features they have been using for years, such as your cell phone acting as a credit card.

- Steve Jobs is Apple. You should read up on their history more if you don't see why. Or look at the period where he was fired.

- People in Crox in 07 made a killing. Just because a stock is low now doesn't mean you couldn't have ever made money off of it.


On Jan 13 08:02 AM User 336307 wrote:

> This author is very one-dimensional in his thinking.
>
> Here are three reasons why...
>
> He assumes Apple has no other large expansion areas. Hello! One word....
> CHINA. A small country with 1 billion iPhone-hungry new users. That's
> where an iPhone Nano will show up first.
>
> Apple has a lot of innovation left in them.
>
> Steve Jobs is not the only person at Apple.
>
> The author mentions crox. Look where it is today!
>
> I rest my case.

Jan 13 08:32 AM

[top_tier:]

Another bogus con fluff piece

Jan 13 08:39 AM

[Cho Cha:]

Didn't China just roll out 3G? (The main reason the 3G hasn't launched yet). What makes their cell service so much better?

Japan does have a better cell network and some carries do offer features not available in the US but many Japanese need to carry multiple cell phones in order to have all of the great features. No Thanks. TV on my cell phone, No Thanks.

Jan 13 09:17 AM

[Zoltan L. K...:]

Please don't treat a tech-company like an easy to forecast FMCG manufacturer. Especially not a market leader with a strategy based on continuous innovation. It is quite challenging to draw a trend in sales, earnings, and product/market-strateg... in advance for such corporations. The iPhone was already declared dead before its preview. It also doesn't help to prepare an anecdotical "histirocal" analysis with a slight resemblance to life-cycle theory. We are having a very tough market, all enterprises, but why should a company with 2/3 of its margins coming from infant products (after having invented several product markets) underperform the market?
Remember: this is the 21st century with technology coming to the masses and converging among market segments. Apple has enormously augmented its client exposure (number and diversity of products, internet, and retail) and it has a very steep experience curve. Just look at the changes of the margins for different product generations (macs, iPods, iPhones). Well, they are growing.
There is no 2nd Apple, only product imitations. Besides, Big Blue once had a beautiful rebirth through its service offerings and it is still not dead.

Jan 13 09:35 AM

[optionsgirl:]

I think you are right, and am now doing aapl spreads on options, only. I don't want to own the stock any longer, just some short term pops for me!

Jan 13 10:01 AM

[question ur...:]

mmmm....a well timed negative AAPL article ahead of earnings release....seen this motis operandi before....

Jan 13 10:23 AM

[question ur...:]

"Finally, I note that at the end of the second quarter, AAPL was owned by a whopping 885 mutual funds ... all of which are now potential sellers."

>>isnt this information a bit dated relative to the rest of your article? Havent some/many of these mutual funds already sold out their positions by end of FOURTH quarter....a reason for a portion of the price drop during the 3rd and 4th quarters??

Jan 13 10:38 AM

[See through it:]

Apple's (the stock) current earnings growth is unparalleled for a company it's size. The stock is also incredibly undervalued. Therefore, the stock should be a great investment. Here's why... Cash earnings (not GAP) YOY doubled last quarter and the stock has a CASH trailing P/E of approximately 12, or 8 if you subtract the cash. In other words, Apple's top and bottom line growth have actually accelerated substantially during a very bad recession. Overlooking these facts gives the appearance that the author is incompetent. Ultimately, the stocks value is driven by its future earnings stream. Apple (the stock) remains a great investment because of the misinformation/ FUD being spread by so many incompetent people in the media. Be patient Apple investors, time is on your side and picking off the misunderstood stocks is what investing is about.

Jan 13 10:51 AM

[See through it:]

"Apple's (the Stock) Best Days May be Behind It - Try Thoratec Instead"

Should really read...

"Apple's (the Stock) Best Days ARE AHEAD - THE AUTHOR SHOULD Try THORZAC Instead. Lutts is a PUTZ! I hate FUD.

Jan 13 11:16 AM

[Thoughtful:]

A True Visionary, er, shill? From your article 8/26/08:

"Today, we're optimistic that the market bottomed back on July 15th -- when it first appeared to many investors that Fannie Mae (FNM) and Freddie Mac (FRE) were going belly-up -- and that since then a bottom-building process has been evolving. We say that because on the charts of most broad indexes, July 15 still stands as the low. Supporting that theory is the fact that there's been no shock as bad as the FNM and FRE scare since then."

Jan 13 12:27 PM

[MikeSX:]

You completely ignore several important elements. A long history of innovation that leads, not follows. With an iPhone nano designed for and about to be released to the China market I will not be selling my apple stock.

When the Apple Tablet, which in another form has already sold more than 18 million units (iPhone & iTouch) is released it will represent yet another paradigm shift and market for AAPL to exploit.

The Application store on iTunes is now producing a revenue stream that did not even exist a year ago. iTunes is now the largest seller of music in the world and now movies and television downloads just a simple and easy as downloading music from iTunes means that AAPL continues to innovate and add revenue streams to the mix of very profitable products that are in high demand for the foreseeable future. Very short sited article.

Jan 13 12:30 PM

[Urbane Gori...:]

Boy! You sure are taking your life in your hands! Don't you know you aren't supposed to say anything bad about the 'Holy Trinity"; AAPL, POT and GE. The mobs will storm your castle by torchlight! Be warned!!

Anyway. You are right. Good stocks become old tired stocks. They may not lie down and die right then, but they develop an odor. Nice article.

jegan ;-)

Jan 13 05:00 PM

[Infinite loop:]

You hit it right on the head when you mentioned perception Tim. Just look at MSFT for a prefect example. MSFT is twice the size it was in 1999 (per revenue), yet it's PPS is down 68% since then.

The market runs more on perception and emotion than anything else. All the finance, data mining and statistics in the world won't change your chances in the market. It's still a 50/50 bet. Fools will try to convince themselves otherwise.

Jan 13 05:32 PM

[Infinite loop:]

Oh, and for all you AAPL perma-bulls, want to know why AAPL is down?

It's called discounting risk. Every company on the planet is in the process of being discounted for risk. P/E multiples will dive due to higher perception of risk in the market. No company is immune to socioeconomic trends like risk reduction.

Disclaimer: I own 5000 shares of AAPL at a basis of $18.

Jan 13 05:39 PM

[jmmx:]

You mentioned both Dell and Microsoft in the article. Well, let’s take a look at them. Below are comparison charts of data from Yahoo of the last 2 year Income statements.

DELL:
PERIOD ENDING ....1-Feb-08 ......2-Feb-07 ....3-Feb-06
Total Revenue ....61,133,000 ....57,420,000....55,9...
Gross Profit ........11,671,000 ..... 9,516,000 .... 9,950,000
Net Income .......... 2,947,000 ..... 2,583,000 .... 3,572,000
--
MSFT:
PERIOD ENDING.. 30-Jun-08 .... 30-Jun-07 .... 30-Jun-06
Total Revenue.. 60,420,000 ....51,122,000 ....44,282,000
Gross Profit...... 48,822,000 ....40,429,000 ....36,632,000
Net Income.......17,681,00... ....14,065,000 .....12,599,000
--
AAPL:
PERIOD ENDING. 27-Sep-08 .... 29-Sep-07 .... 30-Sep-06
Total Revenue. 32,479,000 ....24,006,000 ....19,315,000
Gross Profit.....11,145,000 ...... 8,154,000 ...... 5,598,000
Net Income ...... 4,834,000 ..... 3,496,000 ...... 1,989,000
----------------------...
------- 2 YEAR GROWTH - PERCENT ----
---------------- DELL --------- MSFT ---------- AAPL
T Revenue ..... + 09.3 ---------- + 36.4 -------- + 68.1
Gross Profit .... + 17.3 --------- + 33.3 --------- + 99.0
Net Income ..... – 07.5 --------- + 40.3 -------- +143.0

NOW- Do I need to say any more?

Note – the latest Apple figures do not even account for the “real” (non-GAAP) accounting!!

The question remains: Will Apple continue its growth?
Of course this is going to be affected by the Great Republican Recession. However, it will continue to grow for the reasons listed by so many above:

1- It is the leader in technological innovation and will continue to be so.

2- Its penetration into both the cell phone and computer markets is still small, leaving plenty of room for growth.

Period.

Jan 14 04:11 AM

[Perki:]

Actually, they usually dump them at $5.00, not $1.00.

Is this the pump and dump thread with an AAPL subject line?

Sorry, you have been scammed. Well maybe you are part of the scam?

Anyone else just go to:

www.sec.gov/cgi-bin/br...

There, you can read all about nothing but how much restricted stock they are giving away on this fine little company that offers $900 in stock options when they lose $2.7 ml on $3.5ml revenue and suffer recalls and defective products and more...

What ARE you smoking?

On Jan 14 01:02 PM L. SMITH wrote:

> The stock I love most happens to be one of the "falling angels" (fell
> below $1) .
>
> When a stock fell below $1, many mutual funds dumped.



> Thermogenesis (seekingalpha.com/symbo...) had a minor product
> recall at the worst time of stock market.
>
> No debt, plenty of cash, new products coming out on schedule, no
> real competition on products offered and just about to become profitable
> for the 1st time. Do your dd before investing as always.

Jan 15 12:47 AM