For those who didn't read my article, I explained how I first purchased Apple just over one year ago in November 2011, and I was considering reducing from an overweight position to equalweight after crossing the one-year mark. The reasons for this were quite simple -- I felt that at the height of Apple mania, the continued high expectations for the company were not sustainable long term, and at some point either the company would misstep or a competitor would pose a serious threat to its dominance. So following Warren Buffett's mantra of being "fearful when others are greedy," I thought that it was a prudent time to trim my holdings.
Last Thursday, I passed the one-year mark. I had my finger on the trigger, so to speak, for several days -- but in the end, I didn't sell any of my holdings. And I'm not going to sell this week, either -- or anytime soon, for that matter.
In the past month, a few events have occurred that changed my mind. Although I believe it is important for a value investor to stick to his principles and not flip-flop on decisions, there are times when you need to check your own thinking and admit when you are wrong.
Here are five reasons why I have decided to stay the course with Apple:
- The company has gotten downright cheap - One month ago when I wrote about Apple, it was trading around $636. It has since dropped to $576.80, a further 10%. Off nearly 20% since the highs in September, the company now trades at a forward P/E of 9.83, an EV/EBITDA of 8.76, and a PEG ratio of 0.52. A P/E that low would be below the bottom of the five-year range. How can these valuations be justified when EPS growth rates are still predicted to be near 20% per annum in the coming five years? Even if you assume a more conservative rate of say, 10% growth, with various discount rates, you can still easily justify an intrinsic value in the $800-850/share range using basic DCF techniques. That is a margin of safety of about 30% at the minimum.
- Apple has entered the Magic Formula Screen - Those who have read some of my previous articles may know that I frequently follow companies that show up on Joel Greenblatt's Magic Formula Screens. For those who don't know what this is, the magic formula is a value stock picking methodology. The basic premise of the method is to find companies with a high earnings yield (measured by EBIT/EV) relative to the Return on Invested Capital (ROIC) that they produce. So you are screening for "good" companies at "bargain" prices. Since this past week, Apple has entered the top 50 of all companies listed on the major stock exchanges that are over $1 billion in market cap. This formula often produces companies that have been good businesses in the past, but recently have fallen on harder times, or are expected to in the near future. The fact that Apple is now in top 50 despite its general popularity should turn a lot of heads. Clearly, such a great company with solid prospects and very high returns on capital doesn't deserve the current valuation Mr. Market has given it.
- Buy low and sell high - As a value investor, I am looking to invest in strong companies with competitive advantages that I feel are mispriced in the market. When I consider selling a holding or a portion of one, I need to do so because I feel I can get a better value elsewhere, where I'm sure a higher margin of safety exists. Now that Apple has gotten even cheaper, what other companies offer more value with as strong a risk/reward ratio? None that I've been able to find and feel confident about. Apple has the best balance sheet in the world, and a cult-like following around its products, which gives it incredible pricing power and advantages over its competition. At the bottom of the 5-year valuation range, now is the time to buy a company like Apple -- not sell it.
- The Mini will be very successful - A lot of analysts are doubting whether the iPad Mini will succeed in really taking market share from lower-priced competitors. I think these fears are overblown, and one important aspect to realize is that Apple has always priced its first generation of new products quite high. Next year, the company will likely release the second generation Mini, which is when it will really get interesting, as the first generation will be available much cheaper and will compete head to head on price with Amazon's (AMZN) Kindle Fire, Barnes and Noble's (BKS) Nook, Google's (GOOG) Nexus, and others. CEO Tim Cook has also spoken many times about keeping Apple's core strategy of making fantastic products with a great user experience -- even if they cost a little more. This is what drives the cult following that Apple enjoys, and I think the company will continue to win long term by sticking to its guns and not shifting from this strategy.
- Concerns on Gross Margin are unwarranted - In the company's earnings conference call for 4Q2012, there was some concern about the its projected gross margin decline in the December quarter, and also, the projected year-over-year EPS decline from fourth quarter 2011. I think Apple answered this question very well -- clearly, the sheer introduction of many new products at once this quarter, all with new form factors, has a direct impact on immediate margins. The iPhone 5, iPad Mini, iMac, MacBook Pro 13-inch, iPod Touch and iPod Nano all have new form factors, and were introduced within a matter of weeks of each other. Wall Street and Mr. Market, of course, often have a short-term view, so this immediate impact on margins has hurt the stock. However, as all of these products mature and the fears subside, I expect Apple could easily surprise on the upside with improved margins and very strong quarters the first half of 2013.
Besides the points I've highlighted, I still love Apple for its overall business prospects, balance sheet and dividend, which will almost certainly grow. When searching for ways to deploy your cash, you need to make bold decisions based on the fundamentals of the companies that you analyze. With the current valuation that Mr. Market is offering us for Apple, how can one not stay overweight in the company? The value offered here has just become too compelling for this great business.
Disclosure: I am long AAPL.