As a retiree and a long time Apple (AAPL) shareholder, I am sitting with a very large percentage of my retirement savings concentrated in AAPL stock. I've held on to my growing Apple position over the past three years as much for defensive reasons as anything else. Watching the growth of both the Federal deficit and the Federal Reserve's balance sheet, I had felt the need to take some risk and enhance the value of my portfolio against the likely inflation we will face down the road.
Now I would like to explore cashing out some of my large (excessive!) Apple position and invest in a portfolio of rock solid companies whose diversity represents a more appropriate risk for retirees. Also, heeding Peter Lynch's guidance to "Invest in what you know," I focus on major companies whose brand name products I know well and use.
Brand Name Conglomerate #1 (BNC1)
To evaluate this diversification strategy as an alternative to being very long AAPL, I've put together a hypothetical conglomerate. This conglomerate, which I call BNC1, "owns" all the stock of five of America's best known companies, and its total market cap today is equal to Apple's, as shown in this Table:
Procter & Gamble (PG)
Coca Cola (KO)
TOTAL = BNC1
The Table below compares sales and profits of Apple and of BNC1 (i.e., the total sales and profits of all five component companies) for 2011 and 2007, along with annualized growth for that period and current P/E and PEG using 2011 fiscal year earnings.
Earnings Growth (Annualized)
The Table shows that BNC1 and AAPL are quite comparable, not only in market cap but also in the 2011 earnings that drive their market caps: $29B and $34B, respectively. This is in spite of much higher revenues for BNC1, $189B, vs. $109B for AAPL.
The more striking difference comes in the growth rates of the two and the cost of that growth. While BNC1 and all of its component companies trade at higher multiples than Apple, neither BNC1 nor any component posts the kind of growth that the Table shows Apple has been racking up: 46% per year revenue growth and 62% per year earnings growth since 2007. More recently, Apple's earnings growth has been accelerating: over the past two years to 88% per year, and over the last year to 98%.
In spite of AAPL's earnings acceleration, the market is rewarding the (hypothetical) conglomerate BNC1 with a higher multiple, 19 vs 16.4. This combination of Apple's higher growth and lower P/E results in a still more lopsided PEG ratio, 2.8 for BNC1 and a minuscule 0.26 for AAPL.
Remember, this exercise started by trying to construct a portfolio of solid brand names with the safety of greater diversity to replace the concentrated Apple position in a retiree's portfolio. So what's the conclusion? Does it appear that the safety of diversity in solid companies is a fair exchange for the portfolio concentration in high-growth Apple?
Even with Apple heavily overweight in my portfolio, I can't bring myself to exchange it for anything like BNC1 at the present time. Consider a radical scenario for 2012:
- BNC1 doubles its earnings growth from its 4-yr average to 13.4%, and
- Apple drops from its recent 98% growth down to its four year average of 62%.
In that scenario, Apple will earn $55B to BNC1's $34B. Even with the current compression in Apple's P/E ratio, its market cap will expand to $900B, well above BNC1's $650B.
Of course, if Apple's numbers in this scenario turn out to be at variance with actuals over the next year, I stand prepared to revisit this decision immediately.
On the other hand, if the numbers in this quite believable scenario hold true, this same exercise next year will compare a $900B Apple to an equal sized BNC2, which will include all of BNC1 plus GE (GE) and Time-Warner (TWX). Sounds incredible? That percentage growth over the next year would be comparable to Apple's growth just since last Thanksgiving.
As you hear frequently from commentators lately, "Apple is in an asset class by itself."
Disclosure: I am long AAPL.