What Is Wrong With Apple? Nothing

| About: Apple Inc. (AAPL)

Apple (AAPL) continued its five day selloff which has seen the shares edging correction mode with a 9.9% decline that has erased $50 billion in market capitalization from the company after its meteoric rise earlier this year. I have received frantic emails, text messages, messages, and everything short of telegrams asking me what is wrong with Apple. There was a lot of noise as investors scrambled to decode the freefall that continued on Monday. Let's review the possible reasons why Apple declined Monday:

1. Mini iPad Could Cannibalize Sales:

Surprisingly this is considered to be one of the primary reasons for the selloff. The iPad Mini rumors have been swirling since before Amazon (AMZN) released the Kindle Fire. It does appear that the iPad Mini is closer to being a reality but this new rumor does not justify Monday's price drop. In response to a question regarding iPad cannibalization of MacBooks, then COO Tim Cook responded "was there any cannibalization? Honestly, I don't know for sure. But yes, I think there is some cannibalization… If this is cannibalization, it feels pretty good."

One of Apple's greatest strengths is its willingness to cannibalize its own products before competitors simply overtake them. Cannibalization has become such a vilified term in business but it generally just describes a company with the foresight to adapt before competitors do. For example, does the iPod touch cannibalize sales of the other iPods and the iPhone? Yes it does. Would it be better if Apple never released an iPod Touch and simply let a competitor release a similar product that would steal sales? Obviously no. This type of paralysis is what caused once great companies like Sony to stop innovating due to fear of cannibalizing sales of "cash cow" products.

2. Expectations Are Too High, Time To Take Profits Before Earnings:

Apple reports earnings one week from today and this is the first quarter with new iPad sales included. Apple has been growing at a phenomenal rate and analysts are seemingly fighting to elevate their estimates. It is only natural for investors to get cold feet before earnings but Apple has generally beaten analysts' expectations and I have heard nothing to make me believe that Apple will fail to perform this quarter. There is nothing wrong with being cautious and realizing your gains before a key earnings announcement but other investors should step-in to accumulate shares at a discount.

3. Apple's Weighting Will Be Reduced in the Nasdaq 100 Rebalance:

Out of all the reasons presented I believe this is one of the most significant causes of the share decline from a technical standpoint. Barrons has a summary of the Nasdaq 100 (QQQ) rebalancing that explains why Apple may face additional selling pressure. Before today, Apple accounted for approximately 19% of the Nasdaq 100 which was the largest single holding by a wide margin. Effective April 23 Texas Instruments (TXN) and its $37B market cap will replace First Solar (FSLR) and its $1.8B market cap. The addition of the a company with a larger market cap should put pressure on the large caps in the in the index and force selling of Apple.

Click to enlarge

(Source: Yahoo Finance)

The last time there was a significant Nasdaq 100 rebalance Apple was nearly one year ago when Apple was trading in the mid-300s. Many pundits proclaimed that the selling pressure would harm Apple but I elaborated how to outperform the Nasdaq 100 with Apple. In the last year Apple has crushed QQQ with greater than sixty percent outperformance. In other words, Nasdaq rebalancing can have an impact but even forced selling pressure cannot suppress superb fundamentals.

4. Lingering Department of Justice Antitrust Concerns:

The Department of Justice ("DoJ") accused Apple and the major publishers last week of colluding to control the prices of eBooks. I wrote about this point in detail yesterday explaining why this is a not a significant issue for Apple. To summarize, eBooks are far more important to Amazon than they are to Apple and antitrust analysts expect Apple to prevail over the DoJ. To reiterate a theme in this article, this was very possibly a factor in Apple's decline but should not have a fundamental long-term impact on the stock.

5. Investors Selling High Flying Apple To Pay Taxes:

This is an interesting idea that I heard online. It is somewhat plausible until you consider the magnitude of the selling. It is not outside the realm of possibility to think that investors have been selling Apple the past week to pay their taxes due tomorrow but I do not think that explains the ten percent correction in the shares. Even if this were the case, it would support the justification for Apple rebounded as it has nothing to do with Apple's fundamentals.

6. Australian New iPad 4G Branding Still Questioned:

The Australian Competition and Consumer Commission is challenging Apple to clarify its branding for the New iPad to indicate to customers in the country that none of the wireless carriers support 4G. As a result, the advertising on the package has been an issue despite Apple's online disclosures. This is still a lingering issue but this will continue to have a negligible impact on Apple's financial performance and did not materially contribute to yesterday's decline.

In conclusion, there were no fundamental reasons why Apple has corrected. The company's fundamentals are still very strong and these reasons above are just short-term fluctuations that will be quickly forgotten. The most logical reason is that investors were a little spooked by the DoJ investigation, some other minor negative news, and decided to take profits. I am following the maxim of "the time to buy is when there's blood in the streets (even if the blood is your own)." I applied a hybrid strategy today to capitalize on the steep drop in Apple:

  • Long AAPL May 19 2012 700 Calls
  • Long AAPL Jul 21 2012 620 Calls

The May calls are designed to capitalize on a potential quick rebound in Apple ahead of earnings. I expect Apple to rise near the earnings announcement but I do not expect Apple to rise anywhere near 700. With that in mind, going long the 700 calls at these cheap levels is an attractive way to get Apple exposure and sell it for a quick return if the stock rebounds. Time decay will be rapid with only one month until expiration but at this price I think the reward more than compensates for the risk assumed. The longer term July call is a bet on Apple recovering to its 50 Day SMA in the next quarter. These calls should react favorably to a more modest climb and should show a decent profit if Apple simply returns to low 600s in the next month or so. If options make you uncomfortable you can simply purchase the stock outright and wait for the recovery. Please consult with your accountant or personal financial planner before engaging in any strategy. Regardless of your approach I think this correction is the opportunity that investors have been waiting for and I have taken advantage of it. Many Apple bulls are fearful and this is precisely the time to be greedy.

Disclosure: Author is long AAPL, AAPL May 19 2012 700.0 Calls, and AAPL Jul 21 2012 620.0 Calls.