Apple (AAPL) is a bipolar stock.
In its down periods, Apple seems too good to last - that it's only a matter of time before the abnormal combination of massive new product sales and extraordinarily high profit margins will collapse, taking earnings and the stock with it.
However, in its up periods, Apple appears flawless. In the right place at the right time, the company seems to be riding, even controlling, the technology wave.
My previous articles have addressed both sides. Until last week, my decision (having bought in 2010 at about $250) was to hold. However, on Friday, I sold. Below are the reasons.
When analyzing Apple, it's important to be objective. We need to remove the aura surrounding Apple and its cool products, and take a realistic look at its strengths and weaknesses.
Technology truisms apply to Apple
There is truth in the "too good to last" notion. Extraordinarily high profit margins do not last forever. Competition inevitably makes inroads, forcing former price leaders to adjust or get outsold. Ditto blowout sales from new products. "Must have" excitement can easily and quickly move on to the next hot thing - whoever produces it. The "ultra-books" hoopla at the Consumer Electronics Show and Samsung's new ad campaign are examples.
With technology the infamous "S" curve is always at work:
Excess cash implies limited growth opportunities
Apple's outsized excess cash reserves have been the subject of many articles suggesting that management should use those reserves - investing in growth ventures, paying a dividend, and/or repurchasing shares.
Regarding investing, the problem is that Apple is not capital-intensive. With only $8 billion of plant & equipment, the balance sheet is mostly cash reserves. Apple could force the issue and seek acquisitions elsewhere. Successful companies with excess cash flow have pursued this route in the past, but with varied results (e.g., Google's experience). Perhaps Tim Cook's Apple might be willing to consider it.
Regarding the dividend, although many individual investors like income payments (especially in recent years), experienced growth stock investors prefer capital gains built on a company's superior growth.
Importantly, the buildup of cash reserves (or their use in ancillary acquisitions, dividends or share buybacks) can be viewed as an admission by a growth company that it has limited growth opportunities.
Apple's #1 market capitalization is cause for concern
Market capitalization is the accepted measure of size in the stock market. However, no corporate management would make such a comparison when examining comparative operating statistics. Naturally, Apple and Exxon (XOM) are very different companies in very different industries. However, looking at each company's financials, beyond their share prices and earnings, we see a unique picture for Apple as the U.S. stock market's largest company.
Note that Apple's balance sheet is primarily excess cash and investments. Remove those and shareholder equity drops nearly to zero (making the price/book ratio a silly 100 times). Obviously, what's missing is Apple's enormous goodwill and intrinsic value (the over $300 billion difference between the company's market capitalization and its actual assets). Compare that to Exxon's ~$400 billion market capitalization and ~$300 billion in assets.
The importance of these numbers is that they show Apple's dependence on its abnormal profit margins. Remove those margins and earnings drop significantly (the reverse side of pricing leverage). And, without earnings, Apple's stock price is unsupportable. Unlike Exxon, a product price cut is not a cyclical event accompanied by a raw material cost drop. Moreover, Apple's valuation anticipates significant sales growth with premium pricing, and that depends on a successful, ever-expanding release of new or substantially improved products.
Therefore, Apple's achieving the #1 market capitalization position is cause for caution, not celebration.
The stock chart is producing some sell signals
AAPL's stock chart at first blush looks outstanding: A steady long-term rise tracking supported by the company's sales and earnings growth. However, the 35+% rise since last October is exhibiting the speed and hyperbolic pattern commonly seen near tops.
Here is the weekly chart, back to the 2009 market bottom...
Stock charts courtesy of StockCharts.com
And here is the daily chart showing the latest moves:
These chart warning signs are compounded by the next item…
Apple's new, breathless popularity
Search for "Apple stock" or "AAPL" and we see headlines shouting the good news. With Apple "powering" past $500 on its "breathtaking" rise, enthusiasm has increased:
- CNN: "Even at $500, Apple is still cheap"
- Forbes: "Can Apple Reach $1000 a Share?
Pundits now are listing all the reasons why Apple is undervalued and that crossing the $500 threshold is just the first step to large gains to come. Today's froth offers the look and feel of a top. Applying contrarian thinking, this period offers the chance to sell at a good price and move on to the next opportunity.
The bottom line
Apple has been an amazing company. With Steve Jobs as the key catalyst, it created instantly popular, dazzling new products. Premium pricing was no barrier to sales - in fact, it seemed to substantiate each product's importance, modernity and coolness.
However, Apple's bipolar following has moved to a very high phase, focusing on all that is right. To many who were unimpressed by AAPL's $375 price, $500 looks cheap.
Profitable stock investing requires remaining above the fray and addressing the question, "What's next?" By applying fundamental reasoning, we see that Apple's uncertainties and risks remain. Therefore, this latest stock jump looks to be an opportunity to take our gains now and look for investment opportunities elsewhere.
Remember: Selling doesn't mean forever. We can still return to AAPL, buying when the stock has slumped, investor enthusiasm has moved to the next hot thing and Apple's future looks good.
Does it seem scary (or stupid) to sell now? Why not wait until we get to the top?
First off, tops never feel like tops. They always produce the opposite feeling: That big, easy money is right around the corner. The hyperbolic uptrend draws investors in, because the potential cliff reversal remains invisible and unmentioned.
For me, I have seen so many successful contrarian moves that I don't worry about stepping off the gravy train "too early." Moreover, the decision to do so is supported by remembering Bernard Baruch's observation, "I made my money by selling too soon."
Disclosure: I am long XOM. Positions held: U.S. stocks and U.S. stock funds.