An Apple Mean Reversion: Not As Crazy As It Sounds

Jun.26.12 | About: Apple Inc. (AAPL)

The concept of mean reversion is a prevalent one in investing. It's the principle behind many varied forms of investing ranging from "value" investing to trading on technical oscillators like RSI. It's also the theory behind shorting "overvalued" stocks, a practice that I generally don't utilize, because -- as famously stated by Keynes -- markets can remain irrational a lot longer than you and I can remain solvent.

Nonetheless, the concept has applications in realms outside of stock prices -- for example, the current dominance of Apple (NASDAQ:AAPL). In this article, I'll be analyzing Apple's long-term future and the factors that may cause them to undergo a "mean reversion" and lose their currently dominant grip on the various product markets they target.

Before I get hit with ten million comments calling for my head on a platter, it's important to note that I'm bullish on Apple in the short-to-medium-term, and maybe even in the long term. I believe Tim Cook and the management team are doing an excellent job of carrying on the legacy of Steve Jobs. I've personally made a killing on Apple stock. In fact, my only mistake was selling it too early. Apple is by no means going to collapse as a company anytime in the next twenty years. The point I'd like to make is that during that timeframe, it may face significant headwinds in terms of trying to hold onto its reign as the supposedly undisputed #1 provider of mobile hardware.

Factor 1: The Cult of Apple

Apple's dominance in the market is the result of very good marketing -- not actual product superiority, as I'll be establishing later.

For those who don't believe Apple is a cult, consider the following.

The scenes I witnessed at the opening of the new Apple store in London's Covent Garden were more like an evangelical prayer meeting than a chance to buy a phone or a laptop.

When a team of neuroscientists with an MRI scanner took a look inside the brain of an Apple fanatic... [t]he results suggested that Apple was actually stimulating the same parts of the brain as religious imagery does in people of faith.

- BBC

A lot of Apple product sales are driven purely by this fanatic following. The New Yorker has an excellent article laying out more on this phenomenon. One of their conclusions: everybody wants an iPhone because everybody else has an iPhone. It's a matter of keeping up with the Joneses, even though there are (as I'll establish through the rest of this article) better choices out there. Apple products are for "smart" people. For "cool" people. For "hip" people. So if you want to be smart, cool, and hip, you'd better buy Apple.

(Irony of the year: Occupy Wall Street protesters tweeting about how evil corporations are, from their iPhones, which of course are sold by the largest corporation in the world by market cap. Same corporation that makes world-record profits. But I digress.)

As I established on my very first article on SeekingAlpha (Why You Should Not Like Facebook), popularity is a fickle best. What was yesterday the Hot New Thing can quickly become passe. Take Facebook. It's now being viewed by tweens/teens/young adults as "outdated." They prefer newer social networks like Tumblr and Twitter and Instagram (hence the outrage when Facebook bought Instagram). In the future, they will undoubtedly jump ship again to the next Hot New Network. Cults can't last indefinitely. Apple loving certainly qualifies as a cult, especially because they don't really have the spectacular products everyone thinks they have.

The Cult of Apple is best exemplified by the widespread consumer exuberance over the iPad. Everyone rushed to get one, and everyone is rushing to replace their old ones with the newest models every time they come out. While tablets certainly have some useful applications in a business environment, the truth is that for the vast majority of CONSUMERS, tablets are pretty useless. They're too big to be conveniently carried around in your pocket like a smartphone, yet they're too small to have the same level of functionality as a desktop or laptop. Despite this fact, they cost an inordinate amount.

As a comparison, I'm writing this article on a one year old Dell laptop with a 500GB hard drive, an Intel core i5, and 8 gigs of RAM. It does everything I need it to, and can handle intensive processing (video/audio/photo editing, business database/Excel calculations and models, etc). Yet the laptop cost me only $500 (plus sales tax). The newest iPad would cost way more, and would not help me accomplish any of the various things I use my laptop for. The things the iPad could do that my laptop can't, I can already do on my smartphone.

I'm not the only one who thinks along these lines. Slate writer John Swansburg makes the same point far more eloquently than I ever could:

I got [an iPad] because it seemed like everyone I knew had gotten one for Christmas and, well, I felt left out. I didn't think about how it would fit in with the gadgets I already owned (laptop, Kindle, iPhone), and I didn't borrow a friend's and take it on a test drive. Now I just feel annoyed, having spent $600 on a device that hasn't done anything to improve my life. A salad spinner would have been a better investment, and I don't even eat that much salad.

It's not just professionals, though: parents are buying their kids iPads. We're not talking teenage kids -- I've seen eight year olds walking around with iPads. And you know what they do with them? They play Angry Birds. That's it. I remember when kids used to have $100 GameBoy Colors and be thrilled. Now, to keep up with the rest of their classmates, kids have to have the latest and greatest $800 iPad (not to mention data costs) to play games that have little staying power. (Farmville, anyone?)

This can't last, because it's absurd, cultish behavior. Eight year olds don't need their own computers, let alone tablets.

Factor 2: Apple Hardware: Overpriced, Not The Best

Everyone knows that Apple products command a price premium over all others. But are they better?

Not exactly. Take a look at what a professional thinks about the new Retina MacBook:

The Retina MacBook is the least repairable laptop we've ever taken apart: Unlike the previous model, the display is fused to the glass, which means replacing the LCD requires buying an expensive display assembly. The RAM is now soldered to the logic board - making future memory upgrades impossible. And the battery is glued to the case, requiring customers to mail their laptop to Apple every so often for a $200 replacement.

Even though it's a year old, my Dell laptop has comparable (or in some cases, better) specs than the 2012 MacBook Air. Of course, I can replace it in three years and still spend way less than I would if I bought one of Apple's high end Retina Macbook Pros.

The question you have to ask is if you're willing to pay $500-$1,000 more to own an Apple product that's not superior to other-brand products. Right now, consumers are saying "yes" because Apple has a cultlike fandom. But I don't think that can last forever. (Mean reversion will happen.)

Factor 3: Apple Software Isn't What It's Made Out To Be

I'm just going to come out and say it: iOS sucks. It really does. My one-year-old Android phone does everything I need it to, and with the recent OS update to Ice Cream Sandwich, I'm going to go out on a limb and say it's better than the iPhone. And it's not just me saying that. Head-to-head comparisons show that Android software is superior in several important areas such as mapping, browser syncing, etc. It even has a ton of features that iOS doesn't: customization, Swype, and more.

Android also has a voice recognition software package that doesn't get a whole lot of attention. But guess what? It's better than the vaunted Siri. While it may not give you witty responses when you ask it to marry you, the Google (NASDAQ:GOOG) software is more accurate overall.

In terms of speed and accuracy, Google Voice Actions was ahead in almost all of our tests. Both have strengths and weaknesses, and both are handy convenience features. Siri has a little more colloquial chops and is more "fun," but Voice Search is ultimately a faster, more efficient tool. In terms of performance, the green robot takes the win.

Conclusion: Apple Will Experience Mean Reversion

I'm on the record saying that I believe Apple will continue to expand and exert dominance. Over the next few years, as they tap the Asian market, this is undoubtedly true. But for all the reasons I laid out above, in the long term, I'm not so sure Apple can maintain the steel grip it currently has. After the iPod and the original iPhone, Apple hasn't demonstrated the ability to continue to create truly special products. Whatever they do, other companies can do better/cheaper. Eventually, Apple's cult status will fade, and people will start to make more rational decisions. (Do I really need an iPad? Do I really need to spend $3,000 for a laptop?)

On a more positive note for Apple, it's important to note that the mobile tech market isn't everything. If Apple blows the world away with Apple TV, it may not matter that their mobile products are overpriced and underwhelming. For investors, it may not matter at all -- there are still at least a few more years of blockbuster profits ahead, and with Apple paying a dividend, it might eventually become a "buy-and-keep-forever" stock along the lines of Coca Cola (NYSE:KO). It's really not unrealistic to project a $1,000 stock price sometime between now and 2015. Right now, Apple is priced very fairly. But investors should realize that if Apple starts to experience an unwarranted parabolic increase in P/E, it may hit record highs only to fall back to earth, like many tech stocks did in the late '90s.

Essentially: keep riding Apple for now, but realize that the ride won't last forever. Investors should be aware that Apple doesn't really have a moat. They have a cult. And those are two different things entirely.

Disclaimer: I am an individual investor, not a licensed investment advisor or broker dealer. Investors are cautioned to perform their own due diligence. All information contained within this report is presented as-is and has been derived from public sources & management. Always contact a financial professional before making any major financial decisions. All investments have an inherent degree of risk. The future is uncertain, and actual results may be materially different from those expected. Past performance is no guarantee of future results. All views expressed herein are my own, and cannot be interpreted as the views of my employer(s) or any organizations I am affiliated with. Presentation of information does not necessarily constitute a recommendation to buy or sell. Never make any investment without conducting your own research and reading multiple points of view.

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