On December 16, 2012, I posted an article on Apple (AAPL) suggesting that the AAPL bull story may have reached its climax. Most of the comments on the article were extremely critical, saying that my arguments were extremely off basis as most investors remained enthusiastically convinced that AAPL was indestructible. Notably, I included some long-term charts that were widely criticized in order to provide perspective. Below I have reproduced the same charts:
Cisco (CSCO) 20-year Monthly
Microsoft (MSFT) 20-year Monthly
Netflix (NFLX) 10-Year Monthly
Apple 10-year Monthly
The thesis of the article was that it is close to impossible for a company to maintain above-average growth in earnings over the long term. This is a well established fact in both history and academia. Accordingly, I suggested that one should question the ability of Apple to continue its remarkable bull run. I used CSCO, MSFT and NFLX as comparables. Yes, these companies are very different in a number of ways, but I think there are certain similarities that one should consider.
If we revisit the above charts, one will see that they all contain what is often referred to as "parabolic tops;" a period where investor enthusiasm hits an extreme and price runs up seemingly without end, only to crash not long after. Well, the parabolic top, the move above $400 on Apple, has now been erased, and one is faced with the question of what happens next. You'll note in the above charts the answer is "not much." Growth stocks typically eventually become value stocks, and rarely exhibit the momentum or price appreciation experienced in the parabolic phase. The best examples we have for Apple are Microsoft and Cisco, and one can clearly note that their stocks have been relatively flat for the last decade (one could however also note that stocks in general have been flat over the last decade).
Parabolic moves with flat price action after are not limited to stocks; they have been experienced in commodities and many other markets, and are mostly the result of extreme investor sentiment (recall Silver (SLV) just a few years ago…) Not only was the average retail investor buying AAPL aggressively, but so too were investment funds, with the term "Hedge Fund Hotel" being applied to AAPL in 2012. Not surprisingly, the number of hedge funds holding AAPL peaked at the same time the stock price did.
One will probably note right away that Netflix has doubled since my last posting, and that weakens my argument. I would counter by stating there is one major fundamental difference about Netflix and the other companies mentioned; market cap. Netflix, even after doubling since my last article, only has a market cap of $9 billion, while CSCO, MSFT and AAPL have market caps of $110, $240 and $400 billion each respectively. It is much easier for a smaller company to create and maintain growth than a mega cap. Call it the law of large numbers or something else, at a $400 billion market cap Apple will struggle to generate above-average growth, or even average growth. That being said, NFLX did regain much of the value it lost, however that occurred after a year of consolidation. Recent price action also suggests that bounce over $100 may not hold.
People are still quick to comment that right now Apple is valued very cheap, and that it "must" eventually go up. As of Friday's close AAPL had a P/E under 10, and other relative value metrics deem the stock "cheap" by most standards. But in reality these widely cited multiples ignore growth; the most important factor in any sort of fundamental valuation. It would be wise to accept that Apple will struggle to maintain the growth rate it previously experienced. It however may even be prudent to consider that Apple's growth rate might not only decline, but actually turn negative. What unique technology does Apple have that others can't replicate? What barriers to entry are there? None. Until 2012 Apple experienced a first-mover advantage and was able to extrapolate extraordinary earnings. Three incredible innovations came to market; the iPod, the iPhone, and finally the iPad. What's going to be next in the product development pipeline that is truly going to be innovative? It is possible that there may be another ground-breaking product; I will admit that I originally doubted the viability of the iPad, however the clock is definitely ticking on a new product.
Another problem that remains an issue is sales cannibalization. With every new Apple product developed, one must question the implications new products have on other products. The iPad may have been a revolutionary product, and perhaps it didn't hurt Macbook sales, but I don't hear a lot of talk about iPods these days. Ultimately there is only room for so many devices in a household, and in many markets Apple is already heavily saturated. Sure there's Apple TV, a potential Apple watch, and further potential products, but I think it is safe to say that there is less potential in an iWatch than the iPhone or iPad.
Further, one must consider that Apple products are priced at a premium to comparable brand and unbranded products. Sure, over the last couple years as the economy has grown and stocks have gone up people have been able to afford Apple products. But what happens in the next recession? Most people fail to recognize that although we are in a cyclical bull market, we are still in the secular bear market that began in 2000/2001. Secular bear markets of the past century have ranged from 16 years to 19 years with a minimum of four recessions. The current secular bear we find ourselves in is only 13 years old and has only been witness to two recessions. If/when another pullback and recession of 2003 or 2009 magnitude occurs, should we expect the public to be lining up to buy the newest release of the iPad or iPhone? My guess is no.
It was only a few years ago that in deciding between smartphones most only considered Apple and BlackBerry (BBRY) (this is my experience at least). For those who may have forgotten, BBRY once traded at $148/share. I am not suggesting that AAPL will follow in the footsteps of BBRY, but few people considered a drop in BBRY from $148 to $35 in less than a year, and a further drop to $7 five years later. I remember specifically a time where I had roughly 100 contacts on BlackBerry Messenger, and only two friends who had iPhones. This may be an extreme as I am from Toronto, Canada, but it is definitely worth consideration. It is evidence of how quickly both technology and sentiment can change; two very important factors any AAPL investor must consider.
If Apple truly is worth quite a bit more that currently priced, where are the insiders who should be buying it? Further, why did insiders sell over $150 million of stock between April and November of 2012? Call me crazy, but I imagine most insiders have been around the block a few times and know how to recognize when something may be too good to be true.
Finally one must consider that a stock price, like any other market price, is determined by supply and demand. Yes, demand is determined in large part by the underlying fundamentals. However even if one still believes the fundamentals to be very strong, one must consider whether all the retail investors and hedge funds burned by the sell-off in APPL will be keen to buy in again. History would suggest that the answer to this is "no," or that in the best case it could be a while before the same enthusiasm is experienced again.
Another comment I feel inclined to make is that Apple is just one stock. Regardless of your opinion on it, at most AAPL should not make up more that 20% of your equity exposure, and ideally should be less than 5%. Last month we learned about the rise and fall of Andy Zaky, and the investors whose life savings were wiped out due to his ignorance. Sure, we all make mistakes; I have made many, and will make many more. But by no means should investors ever put their full faith in one stock or an individual with a limited track record.
- Stop the infatuation with AAPL, it is not healthy for your portfolio. Too many people are extremely emotional about this company, and this does not lead to profitable investing.
- If you can't ignore AAPL, consider positioning shorter term and with less capital. It is my opinion that APPL will likely be a stock to trade in, not invest in, for a long time now. I however still consider myself a student of the markets, and would not recommend anyone make investment decisions based off of my advice alone. I simply aim to provide perspective and ideas; always consult with a registered advisor or someone with significant experience (10+ years, CFA, CMT, etc…) and a public track record. If AAPL declares a dividend, it may prove to be a great long-term value play. But as a value stock, I wouldn't expect it to return to $700 anytime soon.
- Stop trying to be an expert on Apple. Last November Citigroup hired three analysts to maintain coverage on Apple, and at the time they had a "buy" rating. If they can get it wrong, anyone can get it wrong. Fundamental analysis in inherently difficult, and it is best applied on small cap or less widely followed names when one is an expert in a field with few such experts.
- If you are going to trade in AAPL, use technical analysis and hard dollar stops. There have been great opportunities in the last year, especially on a risk to reward basis. I don't habitually cover APPL, but in the past years I identified three excellent opportunities based of off technicals alone (see July 27, 2012 for "Great Buying opportunity For Apple", November 13, 2012 "Apple and RIM; Ignore The News", and December 2012 for "Apple Uptrend Over?"). I am not trying to suggest that technical analysis is any easier than fundamental analysis, but it can be much more practical for the average investor, especially in managing risk. If you have the time, read some of the books in the body of knowledge for the CMT designation offered by the Market Technicians Association. Or, if your time is limited, consult with someone who has is experience in technicals and Apple. I, for example, follow a trader by the name of Kay Kim who has made exceptional profits with limited risk on both long and short AAPL trades.
- On risk management; always consider how much you can afford to lose rather than how much you can potentially make prior to an investment decision.
This article may have been overly critical of Apple's future, and the intention is not to suggest that the price will not appreciate, but rather to provide perspective in order to make better decisions. I believe APPL, and stocks in general, will endure a rocky ride over the next year or two. For me to consider a long in APPL I would personally want the $420 level that was tested on Friday to hold. It broke intra-day on Friday, but closed above, and has proved to be a good support area since March. This level could indeed prove to be a double bottom and hold. If however price breaks and closes below that level on high volume, $400, $350 and further levels could be reached very quickly.
I may have strayed a bit in this article, but as APPL is so widely followed, especially by retail investors, I felt compelled to comment on certain topics, some of which are not directly related to APPL, but more so to investing in general. I have spent a significant amount of time in trading and investment analysis, but I am far from considering myself an expert at this point. Beating or outperforming the market is difficult for even the most experienced analysts and traders, yet many people (myself included) still try. Consider this: If you read a book on dental hygiene and had the available tools, would you practice dentistry? If you took art in high school and had a paint brush would you expect to produce a masterpiece? Anything's possible, but one must maintain realistic expectations. Keep an open mind, and always invest with caution, conservatism and discipline, especially when making investment decisions on your own.
Additional disclosure: I may initiate a short and/or a long position in AAPL in the next 72 hours. Price and volume are my primary determinants for trading, and my timeframe is typically short, from a few minutes to a few weeks.