The Apple Enigma: Confessions Of A Reformed Apple Hater

Oct.24.13 | About: Apple Inc. (AAPL)

For a long time, I've been an "Apple hater". I'm unashamed to admit that I'm a PC/Android guy. I like being able to customize things, I prefer those OSes for computers and phones respectively, and especially for computers, I don't like paying Apple's premium margins when I can get an otherwise equivalent machine (with an OS I like better) for a lower price. A year or so ago, I was convinced that anyone standing in line to buy an Apple (NASDAQ:AAPL) product on the day of release was somewhere on the spectrum between crazy and delusional. From an investment perspective, I believed that Apple's margins and revenues might be unsustainable as the "Apple fad" faded and former fanboys opted for cheaper, equally-featured products from competitors.

However, several recent events have caused me to reevaluate my position, which is why I found a recent article entitled "Apple is in Deep Trouble: A Reformed Bull Speaks Out" to be curious. In the article, the author (Josh Arnold) discusses many of the same points I used to think about - commoditization of smartphones, waning of brand loyalty, etc.

I think those arguments certainly still have some merit, and should be considered by anyone considering a position in the stock. But as anyone who read my previous two articles has probably gathered, I tend to believe that for investors, qualitative analysis is as important as (if not more important than) quantitative analysis. Why is that? Well, as several of my professors used to say, there are lies, damned lies, and statistics. My statistics professor obviously disagreed. Nonetheless, the concept is probably valid, and applies to financial models as well. Garbage in, garbage out, as they say - if you really want a stock to be undervalued, all you have to do is tweak the discount rate and assume a few basis points extra margin and revenue growth (things that nobody will really object to) and boom, there you go. Conversely, if you really want to convince yourself a stock is overvalued, discount their cash for repatriation and jack up the discount rate and be extra-conservative in modeling growth and margins, and pretty soon you get to an ugly target price.

For these reasons, I believe models are primarily useful to help you A) understand how the business looks, operates, and is valued under different conditions and B) give you an idea of what sort of price you're paying for it.

But even if I model a company and it looks like the stock is a screaming buy, I will refuse to invest in it if I don't understand the story, the qualitative reasoning behind why this is a good investment. Markets are inefficient, yes, but often not brutally so, especially if we're talking about a mega-cap that gets analyzed to death. If you think a company has drifted from its intrinsic value by a double-digit percentage, then you'd better have some justification for your variant view. If you don't have that justification solidly backed up by your analysis of the situation, then who are you to say your numbers are better than the Wharton guys who get paid the big bucks to do this for Goldman and Credit Suisse and David Einhorn?

So Apple, obviously, looks cheap as an investment. Low P/E, lots of cash, etc. I don't need to get into the details because ten million people (probably literally) have already done that and I'm not adding any value to your day by waxing on about something that everyone already knows. And see, that's the problem - everyone knows Apple's cheap on all the traditional valuation metrics. It's been that way for a while, even when it was growing at a gangbusters pace. When everyone knows something, it's not a variant view. If it's not a variant view, how are you going to achieve above-average investment returns? You're just doing what everyone else is; if you're doing what everyone else is, you can't do better than them. It's impossible by definition.

Where am I going with all this? I agree with Josh on so many of his points - I do think that Apple will struggle to maintain margins if they try to expand beyond ultrapremium products or if their brand loyalty fades. I think most people agree the 5C didn't work out so hot, etc.

Yet at the same time, while I used to call Apple a fad and laugh at the fact that Apple users' brains light up like it's their religion, I also came to the realization that some of the smartest people in my life are Apple devotees. A friend retired from a very lucrative career in management consulting has been an Apple user from day 1; a very smart hedge fund manager has as well. My friend and fellow tech enthusiast Ashraf Eassa called the 5S "gorgeous" after switching from Android and has been raving about the new lineup of MacBooks. There are others (though I know plenty of brilliant PC/Android guys as well).

Quite honestly, I still don't get it, though perhaps my new MacBook (property of my employer - I'm still not a convert!) will change my mind. I'm open to it - in fact, the more I think about it, the more I realize that 90% of my computer time is spent in Microsoft (NASDAQ:MSFT) Word, Excel, PowerPoint, or an internet browser. My experience in those programs should be largely the same as it is now, with a few buttons moved around at the most. Will I become an Apple devotee? I doubt it, although it is kind of amusing to ask Siri where to hide a body whenever I get my hands on my friends' iPhones. (Between that and a few other joke requests, I can only imagine what the NSA thinks of my friends now.)

Anyway, if someone as anti-Apple as me can grow warm to the products, and if many people I really respect are as in love with their iPhones as the next guy, then perhaps my initial perceptions were wrong, and Apple's not a fad. Maybe it really is the next brand as persistent as Coke (NYSE:KO), and it's not the next Motorola (NYSE:MSI) or BlackBerry (NASDAQ:BBRY).

I still don't understand Apple, so I won't invest in it, despite the fact that it certainly looks cheap on many metrics. However, in my reformed position, I cannot fully agree with Josh either - signs I would have taken as "deep trouble" a year ago now look more like continuation of an enigma.

If there's one thing you should take away from this article, it's this: know what you don't know. I'm no longer overtly bearish on Apple, because there seems to be something I've been missing in this story. (Please note: I have never been short Apple. I was bearish on the stock but did not take a position.)

Like Josh, I'm willing to admit when I believe I may have been wrong. In this case, however, we seem to have reversed positions (to an extent - I'm not "bullish", I'm just not bearish anymore). Apple certainly has strengths - I'm amazed, for example, that a laptop shipping out from China a night or two ago is apparently slated to arrive on my doorstep tomorrow afternoon. That takes a lot of supply chain tuning. Plus, Apple's recent A7 chip is a very competitive offering. Apple clearly has plenty of smart people in their organization; I can't claim to predict what they can or can't come up with.

A brief postscript explaining my decision to hold a position in Microsoft but not Apple, despite the former's continuous and egregious attempts to make investors shake their heads. While I'm not confident enough in Apple's business model to invest in it, the one thing I am confident in is that enterprise will continue to remain a strength for Microsoft; Apple will also likely not sacrifice margins to compete in the low end of the market, leaving plenty of room for other players.

Ultimately, while knowing something isn't enough to invest in it, you should only invest in it if you do know it, if that makes sense. If you get Apple and think it's a rock star investment, then I won't disagree with you. If, like me, you don't get it, then that's fine too - plenty of other fish in the investing sea. And if, no matter who you are, you read a point of view you disagree with - whether on Apple or another stock you have a position in - then you should read it with a clear head and determine if there's any validity to the argument. After all, it's your money on the line; why let emotion or pride set you up for a fall?

Disclosure: I am long MSFT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Disclaimer: This is solely my opinion, not an investment recommendation or solicitation, and may not represent the views of my employer(s), associates, or other related parties. No guarantees made to accuracy or completeness. I am long the companies mentioned in the disclosure and may change my position at any time without notification. Please see the full disclaimer in my profile, and do your own due diligence before making any investment.