"The more things change the more they stay the same". That old French saying seems to succinctly sum up the outlook for Apple (AAPL) these days. The company continues to dominate the financial news cycle with each new analyst report, each new rumor, and each new take on what the future for Apple holds. To some extent this level of infatuation is warranted given Apple's standing as one of the largest companies in the world whose products millions of consumers use on a daily basis. My question is at what point in time does it become counterproductive for investors to be so infatuated with a single company that they miss out on other opportunities to generate returns in the market? It is my belief that this is now the case with Apple and that investors need to come to grips that this company may have already morphed into a nice complement to a dividend portfolio and nothing more.
This is a pretty sanguine outlook for someone who has previously been very bullish on the prospects for Apple. It has finally dawned on me that my bullishness is driven more by a lack of downside risk associated with Apple than a real thesis of why the stock should trade significantly higher.
What If Apple Is Now An Income Stock And Not A Growth Stock?
How many investors in Apple today will be happy just collecting the dividend for the next 10 years? There were plenty of investors in Microsoft (MSFT) a decade ago who certainly did not think they were investing in a stock that would be relatively unchanged a decade later. Sure those investors collected a nice dividend each year, but they missed out on significant capital appreciation had they invested in a basket of growth stocks and been smart with when to take gains during that time period. I know that personally, as my belief turns to Apple losing its growth stock status, my desire to make this a core holding in my portfolio diminishes greatly. Is a 2.8% dividend yield from Apple attractive? Absolutely. Is that enough of a return to take the chance that the stock stagnates for the next decade? Absolutely not.
Is it really that outrageous to give up on the growth prospects for Apple? This opinion is probably going a bit against the mainstream, and certainly against the lofty price targets most analysts still have on Apple. There are plenty of reasons to believe that even Apple has already thrown in the towel and acknowledged its growth days are over, with the greatest evidence being the decision to increase the amount of cash used to drive shareholder value through buybacks and dividends.
With the size of Apple's business, the earnings growth outlook and value equation is now much more predicated on the level gross margin % from product sales than the total growth in sales for the company. As a quick example, Apple is expected to generate ~$171B in sales for FY2013 and to see that number grow to $187B in FY2014. If gross margins were to decline by 300bps, say from 38% to 35% in 2013 and 2014 respectively, the total increase in gross margin from the additional sales in 2014 would be completely negated. This is illustrative of how even as Apple continues to grow its top line, it could see its operating profitability erode over time.
Is it feasible that Apple could see this type of erosion in gross margin? The company is seeing this pressure already in 2013. Consumers are fickle, and uncertainty reigns supreme over the future product portfolio for Apple. What Apple has shown this year, with the introduction of the iPad mini, is that the company is willing to compete in lower margin categories. If a rumored low end iPhone is introduced, margins will come under further pressure. The reality is that any product the company introduces will carry margins lower than that seen by the iPhone. Any product that risks stealing share from the iPhone risks diluting the profit outlook for Apple. Investors need not forget that the iPhone single-handily is responsible for the the robust gross margins that Apple generates. Any type of permanent change to the margin profile for that specific product, or changes outside of the company's control such as the end of cell phone subsidies, would have an outsized impact on the earnings outlook for Apple.
It's Time For Most Investors To Turn Their Attention Elsewhere
Previously I would have brushed aside these types of concerns about the growth outlook for Apple, arguing that the company is undervalued and sits on a mountain of cash that will ultimately drive the stock higher as the market recognizes this valuation disconnect. Apple is still undervalued, and still sits on a mountain of cash, but the market does not seem to care. The law of large averages is going to be Apple's greatest enemy going forward.
To earn a 20% gain on Apple, the stock has to increase its market capitalization by about $80B. How many better opportunities are there to find $1B companies that only need to see a $200M increase in value to achieve the same 20% gain. All gains are not created equal, and a small cap growth stock can see a minor change in its outlook that would be enough to drive a 20% gain in a short period of time. How big of a change in outlook does Apple need to see for investors to determine the company is worth $80B more than it currently is today? The only catalyst for Apple is Apple. There is no possibility of the company being acquired, or a leveraged buyout to create value for shareholders. Additionally, Apple in some regards does not even control its own destiny. Whereas Microsoft ingrained itself in the very fabric of corporations across the world, Apple's future is by and large tied to the individual consumer, a fickle and unforgiving soul.
Investors can still find value from investing in Apple, but it is more likely those who succeed will be those willing to trade in and out of Apple, not buy and hold the stock for a decade. For the individual investor, the euphoria over Apple needs to come to an end. Let the big boys and dividend seekers battle it out over the future of Apple. Your time is better spent searching for growth opportunities outside of the world of Apple.
As a parting thought, I hearken back to the Steve Jobs era and the full frontal assault from Apple against Microsoft in its "I'm a Mac/I'm a PC" advertising campaign. Apple was the hunter and not the hunted at that point in time. Today, Apple is blanketing your favorite television shows with an advertising campaign that is pretty much a giant waste of money. The advertising campaign is sweet and sappy and might even tug at your emotions, but it does nothing to make a consumer want to jump off the couch and go buy an Apple product. This is possibly because the advertisement hardly even shows an Apple product, let alone a new product that consumers are left clamoring for. Contrast that with Apple's competitors. On one hand, you have Samsung poking fun at the Applephoria. On the other hand, you have Microsoft using the famed SIRI voice from Apple's products to contrast the limited capability of the iPad compared to a Windows tablet. Anecdotal as this evidence may be, it certainly points to Apple potentially losing its role as king of the jungle.