A couple weeks ago I wrote an article showing the rotation of capital from Apple (AAPL) to other stocks that have seen recent boosts in performance. My theory is that stocks such as Facebook (FB), Google (GOOG), Research in Motion (RIMM), Nokia (NOK), Dell (DELL), Netflix (NFLX), etc. have risen as investors have removed capital from Apple to invest elsewhere, therefore staying in similar stocks. Furthermore, I believe it's quite likely that the re-emergence of Apple will have an effect on these other stocks that have seen large gains as of late. With that being said, the big question is how should you play or invest in Apple, a stock that is undoubtedly undervalued?
Apple is Cheap
Over the last four months I have read countless articles breaking down every aspect of Apple's business, from profit margins to the cost of the company's electric bill. Apple is the most covered stock in the market, and in the process, has become one of the most controversial. In the past, it was believed that the market could not rally without the help of Apple due to its weight on the NASDAQ. The same has often been said for companies such as IBM and Caterpillar (CAT) on the Dow, yet here we are at multi-year highs and Apple has not contributed to the rally. It has been the worst performer.
You see, the argument with Apple having to rise with the market has always missed one very fundamental point, and that is the fact that it only works if the money taken from Apple is then saved as cash. Instead investors have reinvested, yet Apple remains the most watched stock, as investors patiently wait for a chance to buy.
By now you've seen 100's of articles looking at the growth of Apple, therefore I don't want to breakdown Apple and determine whether or not it's growing, if margins are sustainable, whether it's cheap, or if its downtrend has been unwarranted. The answers to these questions are simple, Apple's margins are falling, it trades at seven times this year's earnings minus cash, and is growing by at least 20% year-over-year. Therefore, it's insanely cheap! And if you look and compare it to other stocks such as Google or Microsoft (MSFT) then this fact is even harder to deny. Yet this is not my concern, my concern is the best way to reinvest in Apple where investors could stomach the initial loss, if it occurs.
What Will Happen With Apple?
Since Apple's September highs there have been countless points where we thought the trend was reversing. The stock would have two-three days where it fell $50 but then flatten and then have two days where it would rise $25. As a result, investors would dive back in and then become frustrated and sell once it began to fall. Obviously, it has continued to fall, but it hasn't stopped investors from holding out hope of buying on the bottom and being able to ride the stock back to new highs once this bad dream is over.
Historically, when a stock falls more than 35% over an extended period of time, the stock usually trades in a flat range before trending higher, once finding a bottom. Apple is really not that much different from stocks such as Netflix and Green Mountain Coffee Roaster (GMCR), with the exception of being much cheaper and without as many questions. Netflix fell from its high over $300 (which was clearly overvalued) to around $60. It then had an initial pop over $100 but then traded in a steady range for four months! Green Mountain Coffee Roasters fell from over $100 to $25, it then saw slight gains, before trading in a steady range between $20 and $27 for seven months. There are obviously a number of differences between Green Mountain, Netflix, and Apple, however the purpose is to show you the trend of a stock that falls hard and its journey to recovery. Now, does this mean that Apple will trade flat for four-seven months? Hopefully not, but it's not out of the question.
In my book, I discuss the subject of trends thoroughly, explaining why we make certain investment mistakes/decisions, how we perceive these mistakes, and then how we do or don't learn from money losing events. I broke down a study by Terrance Odean which discusses the fact that investors are reluctant to realize their own losses, at first. A study of nearly 10,000 investment accounts came to the conclusion that investors will hold a losing stock 1.7 times longer than a winning stock. Now, the reason that this occurs is a completely different topic. I could drag this subject into cognitive behavior, brain/neurochemical activity, etc. but the point of the study/fact is that we as investors don't like to admit when we're wrong. Or, when we invest in a company and it falls, we continue to hold out hope, we'll rebuy to regain our losses.
So what in the world does the hold-time of a losing stock and the trends of Netflix and GMCR have to do with how you should play Apple? The answer is quite simple: Those of you buying Apple on every little pop and selling on every little drop need to slow down and take a deep breath. Chances are, Apple will not return back to $700 overnight, but it will remain volatile. It may not trade flat for four or seven months, but if the last decade of market behavior stands true, then we should see a pattern of investors being more hesitant to invest in Apple due to a lack of trust and a loss of significant money.
How Should I Play Apple?
The million dollar question is, "How Do I Play Apple?" If you know the answer, then you can make a lot of money. But unfortunately, no one truly knows the answer to this question. This is a stock that is trading without any reason or logic. It's a fast-growing large cap company that any value investor would tell you is a great buy. Therefore, I don't think there is a question as to whether or not it's a good buy, but rather how to maximize profits, and relive your nerves when investing in Apple, is a different story.
If you're like 95% of the large investment firms in the country, then you have lost significant money in Apple over the last four months; due to its being a large position in your portfolio. And let's face it, you probably can't take another large loss. Therefore, why not spread your investment? If there is a realistic possibility that it could remain flat then why not invest over a longer period of time. Seriously, is there a reason that you have to be either "all-in" or "all-out" Apple? The biggest problem that investors are making is trying to regain their losses. Strangely enough, this fact can also be reverted back to the cited study of 10,000 investment accounts; as we naturally revert to desperate emotional based decisions to regain our investment losses.
My suggestion, as an investor who has lost significant gains on Apple, is to buy the stock over a period of time. Back in December 2011 I sold my holdings in Google to invest in Apple. Apple then became my second largest position due to its large returns. If you still have gains in Apple from a long-term hold, then I suggest you keep some. Personally, I plan to invest 80 shares total in Apple over a course of eight weeks. I have already purchased 20 shares, 10 shares at $500 and another 10 shares at $448, therefore I am still trading with a loss. But, over the course of six weeks I will continue to acquire 10 shares per week which should allow for a stock that is fundamentally cheap to find a balanced trading ground. Then, I feel more confident in my position, but if I would have bought all at $500 then I might have sold or panicked when it fell after earnings. But instead, I feel no sense of urgency and have confidence in my position due to still being able to acquire shares cheaply.
Why Split Up the Purchase?
The answer to this question is psychological. When the stock market is rising, or when we are making money, the same neurochemicals that are released in the brain of a drug addict are released in that of an investor (2011 Journal of Financial and Quantitative Analysis). Therefore, we repeat the behavior over-and-over because of previous encounters of success (not realizing just as many failures); so when we see Apple rising by 2% we try to jump in and capitalize on the trend. But when it starts to fall by 2%, the feeling of loss, that we have already experienced, starts to kick in, leading to desperate actions, especially if you've already lost money. And seeing as how we hold stocks longer when we're losing, most have probably lost even more money in Apple if buying when it's trading higher.
The decision to split up your investment works in several ways: A) it limits the size of your risk, B) it allows you to buy at the best price, and C) it allows you to stomach the losses if they do occur. If I was to buy 80 shares of Apple right now and it fell to $375, I would be tempted to sell even though I still believe that the stock is fundamentally undervalued at $460. Yet those previous periods of loss combined with the large position, and the fact that the market is trading higher, makes it almost impossible to hold throughout the volatility. However, when you purchase in small amounts it doesn't matter what happens short term because you're not fully invested. As a result, you begin to look at the investment in a different way: If it trades lower you know that you've lost some but that you have more shares to buy at a cheaper price, and if it rises then you know that some gains are already locked it and that you didn't "miss out". When dealing with stocks that have lost great value in a short period of time, a buying strategy such as this is necessary to avoid mental pitfalls and emotional decisions that end up costing you even more money.
The neat thing about a psychological strategy is that it doesn't apply to everyone. There are many who can not relate in any way to the strategy or the events that I have explained in this article. However, there are many others who can fully relate. The strategy itself is unconventional but protects you from your own worst enemy, "yourself". It removes emotion from the trade and makes it to where you no longer react when the stock trades either higher or lower, because instead you have a plan that includes buying a certain number of shares on a specific day regardless of its price. It takes discipline to invest with such a strategy, but if you try it, I guarantee that your position in Apple will be much less stressful and your temptations to sell at current levels will be much less severe.