The upcoming Apple (NASDAQ:AAPL
) earnings report is the most anticipated in recent memory. We supposed that all eyes would be on iPad sales, leading many to believe that 2010 stock performance could track the stellar 2007 performance generated from the original iPhone launch. It looks like the first ever quarter of iPad sales will show more units sold than all other Mac units combined. The revenue impact from the iPad will produce an earnings report that is off the charts for a company as mature as Apple.
In addition, iPhone 4 sales tallied 1.7 million in the first weekend. You would think that such numbers would propel this stock on the 2007 trajectory and in fact, they have. 2007 witnessed an initial 64 trading day rise from the iPhone launch and 2010 witnessed a 52 trading day rise from the iPad launch. In 2007 Apple stock then experienced a 30 trading day period of volatility while 2010 has experienced a 59 day period of volatility.
The third phase of 2007 finished with a 44% climb, we'll see what the third phase of 2010 brings...The bears want you to believe that the black cloud of iPhone 4 will put an end to Apple stock price appreciation but there is a major problem with their assumption. If you read the message boards and watch the talking heads you'll notice that 99% of those who are criticizing the iPhone 4 don't actually own one. It's the ignorant who are perpetuating the negative perception. Interesting that the media is so willing to give such people a voice even when this perception of iPhone 4 weakness isn't supported by facts. This new world of unfiltered, unaccountable media took down Toyota in a similar case of false perception. With such a wide gap between fundamentals and perception we arrive at Tuesday's earnings report. There are three legitimate strategies for us to consider:
Strategy #1- Add a 6% allocation of AAPL 2012 $280 calls ahead of the report. Since April 26th, Apple has found itself in a trading range from $237-$275. If Apple jumps back up to the $270 range it will mark the third complete cycle in the last three months. An investor should be buying right now if they believe the iPhone 4 antennagate represents an overreaction of negative short term sentiment and they want to increase positions in anticipation of Apple climbing back to the top of the trading range. Buyers are focusing on revenue growth, profits, free cash flow, and increases in market share that will continue to be generated from the iPhone, Mac, and iPhone segments.
Strategy #2- Hold current Apple positions through the earnings report. The E Weather Portfolio holds 24% in long term 2012 AAPL LEAPS, 10% in mid term 2011 AAPL LEAPS, and 2.5% in short term AAPL calls with 38% of the portfolio in cash. An investor would be holding right now if they are content with the level of risk in the portfolio and believe that the stock is headed up to the high end of the trading range over the next 3-6 months.
Strategy #3- Sell out of the 12.5% allocation of mid and short term AAPL calls thereby increasing the cash allocation up to 50.5% of the portfolio. The latest analyst report from Stifel Nicolaus’ Doug Reid draws attention to Apple’s potential for gross margin decline from an expected 39.5% down to Reid’s forecast of 38.8%; this report spooked the street into a pre earnings selloff. Reid is clearly trying to jump on the negativity of the iPhone 4 by shifting investor focus onto the one detail in Tuesday's report that might be lower than expectations due to the unknown margins of the iPad. I have to hand it to Reid for finding an intelligent way to try and bash this quarterly report. He knows that Apple management will try to keep GM expectations down just as they did in last years April conference call when they projected GM to drop to 33% for the April quarter and 30% for July quarter. Of course those projections were terribly misguided but the current negativity surrounding Apple could cause an overreaction to any kind of GM miss. Clever move by a bearish analyst. If you sell Apple ahead of earnings you believe that the onslaught of negative sentiment will trump the stellar earnings results and Apple will break through the low end of its trading range.
So what are we going to do? Our thesis is that Apple has endured an overreaction from the media. Steve Jobs did a great job of presenting unbiased facts related to dropped calls (less than 1 more per 100 compared to iPhone 3GS), customer complaints (0.55% have complained), and iPhone 4 return rates (1.7%). Such numbers indicate that those who are questioning Apple’s credibility and innovation are misguided. As far as Apple fundamentals are concerned, we are confident that the stock is the best growth opportunity on Wall Street. But instead of trying to predict the volatility of earnings season we are going to hold our current positions in anticipation that Apple will experience a rise back to the top end of its trading range sometime over the next few months. It's very likely that the next run will eclipse the $300 mark. Our 36.5% exposure to Apple calls will do very well when Apple rises. There are two ways to play Apple; you can either be an investor or a trader. We like how Apple is positioned as an investment with expectations low and valuation at the lowest of the Steve Jobs era. Maintaining a 38% cash allocation as well as exposure to ETF’s and other stocks (how about ALIF’s 17% gain since we bought!) allows us to take advantage of any irrational selloff that may happen.
Disclosure: Long AAPL