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Summary

  • Apple underperformed the S&P 500 in 2012 and 2013, as well as Q1 of 2014, but this trend just reversed.
  • Apple's sizable cash position, stock buybacks and dividend growth policies will be increasingly attractive characteristics if the market declines and investors seek out more conservative allocations.
  • Apple may be added to the Dow Jones Industrial Average after its 7-1 stock split. The average needs a new large tech company after the removal of Hewlett-Packard.

Last month, and in advance of the quarterly earnings, buyback increase and stock split information that Apple (NASDAQ:AAPL) recently released, I had proposed Apple shares are likely to outperform the broader market between April and the end of 2014. Now, just a few weeks later, it appears as though much of that anticipated outperformance has already occurred. Nonetheless, Apple still appears like a better holding than the broader market, such as the S&P 500 (NYSEARCA:SPY), between now and the end of the year.

It is still certainly the case that Apple is likely to decline in a broad market sell-off, but it should do better than the broader market, because even with its recent spike, Apple shares substantially underperformed the market during the market's prior year. Over the last two years, Apple shares are up approximately five percent, while the S&P 500 has appreciated by over 37 percent. See a 2-year performance chart comparing AAPL to SPY.

(Source: Google) (click to enlarge)

Additionally, Apple shall continue to hold a sizable stockpile of cash, which it will slowly use for its operations and shareholder-friendly moves, such as stock buybacks and dividend growth. These endeavors and the cash itself should help Apple stay less sensitive to any potentially coming correction. In many ways, Apple has already had its correction.

Apple's cash is largely held overseas to avoid being taxed by the United States, but the company pays its dividend and buys back stock with its domestic cash. The bulk that sits internationally is most likely to be used for device production costs and international acquisitions. Nonetheless, Apple has shown itself to be highly disciplined in its use of cash, and it is entirely possible that it will refrain from utilizing the bulk of its overseas cash until the right opportunity presents itself. Such may not occur until a correction does, but Apple will have the ability to strategically acquire assets then on sale, if equities do broadly decline.

Apple's costs for ramping up production of a new Apple device or model of an existing one are significant, as are the global marketing and distribution budgets surrounding an Apple product launch. Nonetheless, given that Apple is holding at or above $100 billion overseas, and growing, it is unlikely Apple could use more than 25% of this overseas cash on production, distribution and marketing of new products in 2014, even if it releases a new iPhone, iPad and MacBook, as well as some rumored new product(s), such as a watch or television. Given Apple's growing international business, it is entirely possible that the overseas cash position will increase in the second half of the year, and especially on a per share basis.

Apple bought $14 billion in its own shares after reporting Q4 earnings in January, and the move appeared to set a price floor. Apple subsequently reported increasing its repurchase plan. The company has been opportunistic in its buying of shares, such as the large purchasing after reporting somewhat disappointing holiday quarter earnings, and will likely again accelerate shares if any broad correction or bad news hits its share price. Similarly, Apple's already competitive and growing dividend should become more appreciated during any correction, and generally.

While Apple considers new products and acquisitions, competitors are making them. Google (GOOG, GOOGL) bought numerous companies in the last year, including Nest, which makes sensor-driven, smart thermostats and smoke detectors, and multiple robotics companies. Similarly, Facebook (NASDAQ:FB) recently made some substantial acquisitions, including WhatsApp, a cross-platform mobile messaging service, for $19 billion and Oculus, a virtual reality headset maker, for $2 billion. While it is far from clear whether these acquisitions will produce value, it should be noted that many thought it was absurd for Facebook to acquire Instagram 2 years ago for $1 billion, but that acquisition now appears shrewd.

The largest unknown for Apple's second half of 2014 is how well its products will continue to do in China. Apple's recent relationship with China Mobile (NYSE:CHL), China's dominant mobile phone carrier, boosted iPhone sales in the previous quarter, but it is unclear whether this trend will continue. Apple will probably recognize a benefit from it. It already appears to be the case that the iPhone is unlikely to have a majority share of the market, but it has established itself as one of the high-end smartphones, both because of the functionality of the device and that owning the newest Apple products is a status symbol.

Apple's establishing of its products as a designer or luxury option should help maintain a relatively high profit margin on the hardware, as well as prompt consumers to aspire towards its ownership. Of course, there can certainly be other luxury options that will carve up the higher end of the market, such as certain Samsung (OTC:SSNLF) models, among others, but Apple appears to have sufficiently entrenched itself into the space that it would take a significant change in technology and consumer sentiment to change its position.

Apple also recently reported that it intends to split its shares later this year. This move may be to make its shares more accessible to retail investors, but it also might prompt the company to be included in the Dow Jones Industrial Average (NYSEARCA:DIA). The DIA is price-weighted, and the equities within it generally split before their share price goes too high. IBM (NYSE:IBM) and Visa (NYSE:V) are the two highest-priced companies within the DIA, and Apple is priced at around triple their prices per share. After the forthcoming 7-1 stock split, Apple will likely be priced per share within the middle ground for the DIA, making it a somewhat ideal addition.

In 2013, Hewlett-Packard (NYSE:HPQ) was removed from the DIA, along with a couple of other companies, but no new technology company was added. Apple would have been a sensible replacement, but its high stock price made it an unacceptable entrant to the average. The next time a company leaves the DIA, it is entirely possible and even likely that Apple will be added. Such an addition would force many ETFs, mutual funds, pension plans and other investment vehicles to accumulate Apple shares in accordance with and proportion to Apple's position within the DIA, which will be a function of its price. This simply means that if Apple is added to the DIA, there will be an automatic increase in demand for shares. It is also quite likely that many institutions will acquire shares in advance of such an announcement, or acquire options to hedge the possibility, to secure a potentially lower price.

For these reasons, Apple appears likely to continue outperforming the broader market between now and the end of the year.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

Source: Apple Still Likely To Outperform The Market Going Forward