In the past few weeks Apple (AAPL) stock has rebounded from a low around $390 on April 19th. The stock hit $463 on May 8th and has taken a dive in the past couple days. Seeking Alpha contributor David Trainer, who wrote Apple Bears Are Wrong one year ago, just changed his opinion. In Danger Zone For This Week: Apple, Mr. Trainer compares Apple's return on invested capital to Microsoft (MSFT) and Google (GOOG), he states:
If we assume Apple can maintain an ROIC close to Microsoft's, around 75%, then the stock is only worth ~$295. If Google's 34% ROIC is the benchmark, the stock is worth only ~$191.
Let's take a look at one measure of Apple's ROIC compared to Microsoft and Google:
AAPL Return on Invested Capital data by YCharts
Notice YCharts finds different ROIC numbers than Mr. Trainer; his research firm, New Constructs, defines ROIC as:
It is equal to NOPAT (net operating profit after tax) divided by Average Invested Capital. It can also be calculated by multiplying the NOPAT Margin by Average Invested Capital Turns.
Average Invested Capital is the average of beginning and ending invested capital.
YCharts' formula is:
ROIC = Net Income / (Shareholder's Equity + Total Long Term Debt)
Some ROIC formulas subtract a company's cash from equity and debt to determine average invested capital. Regardless of the exact formula used, investors should be mindful of the fact the trends for these companies are going lower. While return on invested capital is an important indicator, Mr. Trainer's downside target seems unrealistic. He writes:
If we assume Apple can maintain a long-term ROIC of 20%, which is still high in the consumer electronics sector, the stock is worth ~$162.
If Apple were to drop to $162, its dividend yield would be 7.5%, this seems unlikely. Apple made $39.5B net income in the past four quarters, that is $12B more than Microsoft and Google combined, over the same period. So to say its market cap should be well below Microsoft and Google's based on ROIC, seems not to take the whole financial picture into account.
Apple: The First Problem ...
As I was reading Danger Zone For This Week: Apple, I had the film Trading Places (1983) on television. I noticed an Apple Computer product placement on the back of a prop Wall Street Journal, being read by Mortimer Duke:
The film's director, John Landis spent time at Skywalker Ranch, where Industrial Light & Magic (DIS) was using Apple Computers. At the time his wife, Deborah Nadoolman Landis, was costume designer on Raiders of the Lost Ark (1981) with Steven Spielberg and George Lucas. The Trading Places filmmakers likely knew Apple had extraordinary applications, having worked with Spielberg and Lucas as they used special effects to greatly advance cinematic storytelling. A couple years later Steve Jobs bought Pixar from the Industrial Light & Magic team.
In Trading Places the wealthy Duke brothers plan to steal a crop report, and invest in frozen orange juice futures before the report is made public. Mortimer Duke is so concentrated on the oranges, he misses the ad for Apple, right under his nose. By the time the story ends the once wealthy brothers wouldn't even be able to afford the $1,400 desktop computer being advertised.
Apple: First $1B Personal Computer Co. = Popular Culture
Apples and oranges are a prominent theme in the film, in addition to conveniences afforded by modern technology:
The theme is furthered by the Duke brothers' extravagance compared to the working class. Their chauffeured Rolls Royce is equipped with car phones and computers to track the market.
Apple Computer's product placement and promotion basically said to moviegoers: "You can afford these too, think about giving a computer to your family for the holidays." The "problem" was not simply what gift to give, it was the cost; the result of solving the problem was access to the power of personal computers, and ultimately the greater problem solved was archaically slow access to information. Simply put, the internet would not exist in the form it does today if it were not for Apple.
The attempt to corner the silver market was made by brothers Nelson Bunker Hunt and Herbert Hunt. The sharp sell-off occurred once the two men were unable to meet various margin calls... caused by short-term weakness in the silver price. A group of U.S. banks needed to step in with a $1.1 billion line of credit
The Duke brothers ultimately bet $394 million on margin; not realizing they were duped and stole a fake crop report.
Though Trading Places was produced 30 years ago, some investors have not learned the important investment lessons it explores. This rings true when very wealthy groups, like the defunct MF Global and Rochdale, gamble with far more than they can afford and lose everything.
Apples & Oranges: Still Different 30 Years Later
Trading Places was released in 1983, the year Apple released the Apple IIe (enhanced) and the Apple Lisa, priced at $1,400 and $10,000 respectively. Ironically, in the short-term neither Apple computer nor the film's fictitious frozen orange juice fluctuation would have turned the Duke's investment into a fortune.
This is Apple's split-adjusted chart from 1983:
AAPL data by YCharts
Had investors thrown more money than they had into Apple in the first two quarters of 1983, they would have lost money in the short-term. However, investors with a strategy, who allocated to the company each quarter, for the long-term would have made hundreds of percent.
From Apple IIe to iPhone5: Solving Problems
In the past, ownership of an Apple computer meant a household was modern. Other computers required an expert to setup, whereas the Apple was ready to go, out of the box. Today, the market for computers is vastly different; laptops, tablets and phones have made desktops less of a necessity.
Let's take a look at the iPhone 5, and some of its applications, to see if Apple is still solving problems large and small:
The iPhone5 starts at $199 and offers tremendous functionality; it can be customized with applications offered through Apple's App Store. At last count there were approximately 775,000 apps in the App Store and just yesterday Apple announced its 50 billionth app downloaded.
Though I like Apple's designs, I am the first to admit, I believe some of the applications like iMovie and iPhoto (available at the iPhone App Store for $5) could be stronger. Apple did acquire Final Cut Pro video editing software in the late 90s; now used by professional filmmakers all over the world. Final Cut Pro currently goes for $299 at Apple's App Store, however is not available for the iPad or iPhone. The iPhone's built-in apps include:
- Siri (voice recognition)
- Passbook (stores event tickets and gift cards digitally)
- FaceTime (Internet video chat)
- Newsstand (automatically downloads your daily newspaper)
- Find My Phone
- Siri compatible Stocks app (to track your investments.)
Competitors have tried to take jabs at the iPhone, though Apple's products maintain popularity. While competitors are still working on early versions of their phones, Apple has advanced and polished their designs. The company has encountered some obstacles, with Maps and Siri, though it appears they work to resolve them.
When Apple releases new products, its competitors scurry to make similar products. Conversely I do not see Apple working to design or release consumer products exactly like its competitors' recent inventions. Though some feel there is a lack of innovation, it seems to me Apple contributes significantly to the modern digital age.
Apple Is For Long-Term Investors (With A Strategy)
Some analysts value return on invested capital above other performance metrics, others rely on revenue growth, or P/E, or EPS, or any one of many indicators. I believe the momentum of a stock's price is an important factor, if a stock goes up too fast it could be followed by a drop. However, most importantly I look to what I believe a company is worth, and to the whole company's value; I ask if the company is worth owning a part of?
Furthermore, I believe it is important to implement a strategy. A key to a strategy is setting benchmarks; realize Apple, just like any stock could go up or it could go down. Understand that its dividend could also go up or down. Have a plan for Apple going below a certain point, and a plan for it going up to a certain point. Most importantly, learn from valuable lessons you can relate to; regardless of the size of your portfolio.
Look for strong profitable companies to balance investments, and consider what proper allocations to technology are for your comfort zone. If you do this you hopefully will not feel like one position endangers your portfolio if it has a bad quarter or bad year. I have not given up hope on Apple, because I think the company is important.
I keep allocations to Apple, and most companies, at levels where even if they fall 50% the portfolio will not take too much of a hit. Furthermore I try to allocate certain percentages to stocks, certain amounts to bonds and certain amounts to mutual funds and cash. For instance if you have 2.5% allocated to one company, if the stock falls 50% the portfolio will only be off 1.25%. If you have income generated from bonds and mutual funds regularly, the cash can be used to build up positions over time. Whereas if an investor takes on more risk than their portfolio can handle, such as the Duke brothers or the Hunt brothers, they could be in for a real problem, because the market can be anything but predictable.