Why Google Could Fall If Apple Rises

Jun.24.14 | About: Alphabet Inc. (GOOG)

Summary

The one-year chart comparing the performance of Google with Apple seems to show divergence, if not negative correlation in the latest portion.

There are legitimate reasons why a rise in Apple could prove a catalyst for a decline in Google shares.

Portfolio managers mindful of investment discipline limiting sector and beta risk could replace the capital appreciation, profit-packed Google with the relative bargain available in Apple, driving down Google shares.

It's a legitimate question to ask. Might Google (GOOG, GOOGL) shares fall if Apple (NASDAQ:AAPL) shares rise in coming months? Some will say that even if it occurred, it would be coincidental, because the paths of the two stocks are mutually exclusive. But are they?

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1-Year Chart Comparison of GOOGL & AAPL at Yahoo

The one-year chart comparison of the performances of Google and Apple shows rising shares and positive returns across the board. However, you will note that the most recent history seems to portray at least a divergence if not negative correlation between the two. There are other than operational reasons why that might be, and we get to those herein.

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2-Year Chart of GOOGL vs. AAPL

The skeptics will point to the two-year chart comparison of the two stocks, which shows the clear outperformance of Google. It shows how much more Google has satisfied investors over Apple, and it says something about the performance of the corporate managers within the two firms. Apple buffs will cry foul, and say Apple's value has been unrecognized and criticism unwarranted. They will argue that over time this anomalous divergence will correct and bring Apple shareholders excess returns over Google. That may be so, but it still would not rule out the possibility of Apple's gains causing Google pains. For those interested in investing in Apple, my recent work Apple's Playbook Revealed should prove valuable.

Why might one move cause a counter move in the other stock?

Large managed funds like mutual funds and others often keep to a disciplined investment strategy limiting investment sector exposure. Portfolio managers might allocate funds to the technology sector up to a certain percentage of their total holdings. Funds may seek to completely avoid excess sector exposure by matching the weighting of each sector to their benchmark index, which could be the S&P 500 (NYSEARCA:SPY) or other index. If those funds are now adding Apple shares to their portfolio then they will need to sell something else to keep their technology sector exposure in check. Why they might choose Google over another name could be due to the fact that it competes in many of the same markets as Apple, and/or because of the valuation differential between Google and Apple. Google's P/E and PEG ratio using trailing twelve month EPS and consensus expectations for five-year growth are 30X and 1.9X, versus Apple's P/E and PEG of 15.3X and 1.0X. Interestingly enough, analysts see similar 5-year growth for the two firms (15% to 16%), so there appears to be a significant valuation anomaly.

The valuation anomaly drives other reasons for other portfolio managers and investors to consider buying Apple and selling Google at the same time. Those fund managers specializing in the technology sector and perhaps benchmarking to the all-tech Technology Select Sector SPDR ETF (NYSEARCA:XLK), will have no sector concerns but might keep industry weighting discipline; these funds might also exchange one stock for the other stock due to their competing businesses. Investors without any concern for industry or sector discipline might simply exchange the recently profitable Google for the apparently undervalued Apple based on valuation and the theory that stocks will tend toward a mean intrinsic value.

Finally, hedge fund managers or long/short managers of any sort who both buy and sell short stocks in order to neutralize beta or to maximize alpha returns, could employ a pair trade strategy. Such investors could actually sell Google short and buy Apple as a pair trade strategy, which would serve to sink Google shares while boosting Apple.

I can conceive of one more possibility, though it would be a rare and likely insignificant driver of capital between the two stocks. However, in conjunction with the other reasons why investors might penalize Google while buying Apple, it could prove important. There could conceivably be funds that trade around stock splits, which could currently be buying Apple due to its recent 7-for-1 split. Since Google split its shares not long ago, but not recently either, those same investors could be selling Google now due to time passage. I'm not saying this would be a good strategy or not; just that there probably are some fund managers and funds which might employ it as a strategy. Likewise, though, there could be funds and managers that employ the opposite strategy, so this is clearly the least important of the factors I have outlined here.

My list of reasons why a surge in Apple shares might lead to a fall in Google shares could be incomplete, so I humbly invite readers to offer anything more they might conceive in the comment section of this article. Likewise, if some readers have a contrary opinion, please feel free to offer it in order to add value to the discussion. For more on why I think Apple shares are poised to rise, see my article linked above, Apple's Playbook Revealed.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.