Apple: Why You Should Not De-Apple And How To Do It If You Really Need To

Summary

• You might be concerned that you are holding too much Apple stock (rightfully so) with its market capitalization approaching $3 trillion.
• Is it time to de-Apple, to reduce the concentration risk, and to better diversify?
• Ray Dalio called diversification the “Holy Grail of Investing” for good reasons. However, the subtleties and fundamental limitations are often ignored.
• This article will examine the fine line between diversification and deworsification, and show it’s never a good idea to diversify just for the sake of diversification.

P_Wei/iStock Unreleased via Getty Images

Thesis and Background

In his book Principles, Ray Dalio called diversification the “Holy Grail of Investing” and made the following comments about this chart:

That simple chart struck me with the same force I imagine Einstein must have felt when he discovered E=mc²: I saw that with fifteen to twenty good, uncorrelated return streams, I could dramatically reduce my risks without reducing my expected returns… I called it the “Holy Grail of Investing” because it showed the path to making a fortune.

Source: Ray Dalio’s Principles.

Diversification probably is the first concept that every investor learned. And the above chart is indeed a very powerful chart, and most of us surely understand the key message here – and the message seems to motivate the questions that we started with:

• Should you be concerned that you are holding too much Apple stock (NASDAQ:AAPL)?
• Are you exposed to too much concentration risk with your AAPL positions?
• Should you trim your AAPL positions and better diversify?

However, as with many other powerful tools, diversification is prone to be overused and even misused. So it is the goal of this article to examine this powerful tool closely and answer the above AAPL related questions.

AAPL: how much are you holding?

Firstly, you need to understand how much APPL you are actually holding. The following chart shows the weight of AAPL in some of the most popular indexed funds. As seen, as of this writing, Apple is about 11%+ of the NASDAQ index (represented by QQQ), about 6.6% of the S&P 500 index (represented by VOO), about 5.5% of the US total market fund (represented by VTI), and about 3.3% of the total world market fund (represented by VT).

Are such levels unprecedented for one stock in a broad index? Yes, they are. As we enter our information age, for better or worse, the powerful network dynamics created certain winner-take-all market sectors. And the emergence of dominant mega-players is simply inevitable.

Are such levels alarming? No. Firstly, it is more of a personal preference - I feel very comfortable parking a few percent of my overall asset on one stock. And secondly, as we will see later, the additional benefits of diversification are quite marginal to hold 50 stocks with 2% weight each vs holding 10 stocks with 10% weight each. In this case, even if QQQ is the only fund that you hold, your exposure to AAPL is only 11.3%.

Of course, if you have other exposure to AAPL (like AAPL shares themselves) in addition to these index funds, then you should first review your inventory and see how much you are actually holding.

Source: author

Diversification: the Holy Grail’s limitations

After you get an accurate inventory of your APPL shares, let’s see the often-neglected subtleties of diversification.

First subtlety – are they correlated?

The first key subtlety is the correlation among your holdings. Let’s read Dalio quote again (and this time I've added an emphasis below):

I saw that with fifteen to twenty good, uncorrelated return streams, I could dramatically reduce my risks without reducing my expected returns

The operative word is that these return streams have to be uncorrelated to effective diversity. Most of us understand that choosing different stocks within the same sector (like holding 20 banking stocks) does not help to diversify. However, many of us probably are not too aware that stocks across different sectors are quite correlated to each other, and that correlations impact diversification too. The chart above shows that when the stocks are correlated, the marginal benefits of holding additional stocks decrease quite quickly. Let’s examine this more closely. Say if we have a large set of stocks that are 20% correlated with each other. As can be read from the following chart, picking 10 of them already captured more of the benefits there is to be captured by diversification, as illustrated by the green arrow on the left hand. Adding more stocks does little to help, because there is a little left to be captured anymore (as illustrated by the blue bar on the right-hand side).

As the correlations among the stocks decrease, the additional benefit would increase. But as you can see from the chart, even if the correlations decrease all the way to zero, holding 10 of them will already capture most of the benefits of diversification (the orange arrow vs the purple bar).

So what is the actual correlation among stocks then? The answer is that they are typically more than 20% correlated with each other.

So for better or worse, in reality, no matter how many stocks you hold, the additional benefits of diversification are quite marginal beyond about a dozen or so (that is why Dalio mentioned 15 to 20 himself).

Source: Author based on Ray Dalio’s Principles.

Second subtlety – are they good?

The second subtlety is these ideally uncorrelated streams need to be “good”. Holding 5 A-grade stocks at 20% weight each is better than holding 5 A-grade stocks plus another 5 B-grade stocks at 10% weight each. This is the fine line between diversification and deworsification. Replacing some of your AAPL shares may not help your better diversify because of the correlation issue mentioned above. Furthermore, it may actually increase your risks if the replacement is worse than AAPL even your portfolio seems to have more holdings with more equal weights on the surface!

So do you have replacement ideas that are better than Apple? I am sure there are stocks out there that are better than AAPL (whether we can find them or not is a different issue).

However, it’s never a good idea to diversify just for the sake of diversification and it is quite hard to find better replacements for AAPL. Because, as to be seen next, AAPL is far better than most of the stocks in the aforementioned indexes. Simply reducing AAPL and adding other stocks most likely will lead to deworsification rather than diversification.

Diversification or deworsification?

The next chart shows a comparison of the fundamentals between AAPL and the S&P 500 index. The chart compares them in terms of valuation, financial strength, and profitability. Firstly, as you can see. The valuation of AAPL is only slightly higher than the overall market, by about 4% in terms of the PE ratio. In terms of the EV/EBIT, AAPL is actually valued the same as the overall market because of its lower debt ratio as we are going to see next.

In terms of financial strength, AAPL is far superior to most of the businesses in the S&P 500 index. Take its debt coverage as an example. Here the debt coverage is defined as EBIT income divided by net interest expenses (“IE”). It is about 25.2x for AAPL, compared to less than 10x for the S&P 500 index.

In terms of profitability, AAPL again is far superior to most of the businesses in the index. Its operating margin and net profit margin are, respectively, more than 2x and 3x better than the average of the index. Let’s look beyond the forests and look further into the trees. Among all the subsectors consisting of the S&P 500 index, the technology sector (represented by the SPDR fund XLK) and the communication services sector (represented by the SPDR fund XLC) currently have the highest net profit margin. As shown in the second chart in this section, their current net profit margins are 19.1% and 13.3%, respectively. Such margins are indeed significantly better than the overall S&P 500 index. However, APPL’s margin is just far too superior even when compared to these most lucrative sub-sectors. And a thick margin by itself is a wide and stable economic moat.

So the overall picture is pretty clear here – AAPL is no more expensive than the overall market but it offers far superior quality. Funds (especially passively indexed funds) seem to be a dead-end to me already for the reasons just said. In terms of individual stocks, your odds of finding better replacement stocks for AAPL are also slim given that A) AAPL is so superior to the overall economy or its subsectors, and B) the whole economy and its subsectors are made up with individual stocks.

Source: author based on data from Multpl and csimarket.com.

Source: author based on data Seeking Alpha and Yahoo Finance

Conclusion and final thoughts

Ray Dalio called diversification the Holy Grail of Investing for good reasons. However, the subtleties and fundamental limitations are often ignored. When these subtleties are applied specifically to AAPL, the main takeaways are:

1. For better or worse, no matter how many stocks you hold, the additional benefits of diversification are quite marginal beyond about a dozen or so. And AAPL is no exception here (with its scale and reach, it is probably more correlated to other stocks than average).

2. Furthermore, to effectively diversify, you not only need uncorrelated stocks, but they need to be “good” too. Replacing some of your AAPL shares may not help your better diversify because of the correlation issue mentioned above. Furthermore, it may actually increase your risks if the replacement is worse than AAPL even your portfolio seems to have more holdings with more equal weights on the surface. In AAPL’s case, it is no more expensive than the overall market but it offers far superior quality, posing challenging odds of finding better replacements.

3. However, there are definitely good reasons for some investors to de-Apple. Different investors have different risk tolerance levels, and some investors may just hold too much of it. For investors who really to de-Apple, here are a couple of ideas:

• You could consider replacing some of the indexed funds mentioned above (e.g., QQQ and VOO) with RSP. It is the Invesco S&P 500 Equal Weight ETF and it offers an equal weight indexing of the 500 stocks in the S&P 500 index. So AAPL’s weight in this fund is only about 0.2%. By mixing RSP with your other funds, you could tailor your exposure to AAPL.
• If you hold AAPL shared directly, you could consider replacing some of the AAPL shares with Berkshire Hathaway (BRK.B) shares. As argued in my earlier article here, this replacement could help you in two ways. First, you effectively reduce your AAPL exposure by about 60% because each BRK.B share contains “only” 0.4 AAPL shares. And secondly, it might also reduce your ownership valuation of AAPL (to about 12x PE as argued in my earlier article).
• Last but not least, do consider tax complications when you switch positions too. In non-tax-sheltered accounts, your replacement ideas not only have to be better than AAPL, they have to be at least about 20% better to overcome the tax alone (assuming the average federal and state tax rates on capital gains). Depending on your specific situation, buying a put option might end up being a more cost-effective way to hedge your AAPL position rather than trim/replace it.

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Analyst’s Disclosure: I/we have a beneficial long position in the shares of AAPL either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Comments

[Envision Research]

* Several comments mentioned more details of the SP500 valuation.
I want to do a bit of hair splitting here - the valuation of "SP 500" is different from the valuation of "the market". The S&P 500 valuation is distorted by a few mega-cap and highly valued stocks like NVDA and TSLA. So SP500 is highly valued (at PE around 30x) but "the market" may not be - as long as you exclude these outliers.

* Also some comments also mentioned the geo-political aspects of diversification. In AAPL’s case, it has higher China-specific risks (maybe triggered by a Taiwan crisis) than some investments. This is definitely a factor that my article has not covered. And I am thinking about ways to better quantify such aspects.

I am particle interested in A) ways to better quantify the China risk for AAPL, and B) ways to show why/how AAPL has more (or less) geo-political risks than other business (say S&P 500 on average of MSFT for example).

I’d love to hear more comments and ideas for further analyses. And I’ve love to see a full analysis from someone else too.

[user1102170119199187]

@Envision Research

Thank you for the article, very informative about investing in general to help improve one's acumen.

It's been a little over a year since I've ventured into individual stock investing and, although my performance may have lagged in this short period of time, I'm slowly implementing what I already know about holding a portfolio filled with quality companies and not over-diversifying with too many stocks.

I appreciate the article help to reaffirm my investing approach.

[Dividend Latitude]

When I finalized my portfolio for retirement, AAPL was my 11-th largest position out of 14 dividend growth stocks. It has grown to #2 now, in a little over 1 year. Amazing.

I cannot imagine selling any shares just to "rebalance". Only if I need the money for living expenses.

[TurboRocker]

You should not de-Apple b/c Apple owns at least the next decade in terms of the tech/mobile world (likely more than the next decade).

[UNIPantherMSW]

Thank you for the article. Quite a few years ago I started a Roth and went 66% AAPL, 33% JNJ. I've not touched a share of either--- although it's now like 85-90% AAPL...but the two combined continue to achieve Alpha year after year as a pair! I wish I'd learned the lesson of just buy the best companies and be patient much earlier in life!

[citikid]

Well written article and Interesting perspective.
I think I’ve been practicing something like this intuitively for most of my investing years.

I picked up a bunch of AAPL Jan 2019 when there was an unusual pull back before their last split. I wish I had bought more. I’m getting ready to sell enough to recoup my seed money and then set and forget. All house money. Then back to looking for more opportunities.

I did the same thing with NVDA and TSLA a while back, among others.

I do have a few actively managed funds that hold AAPL et al. but I trust the managers I chose to keep an eye on that for me.

Thanks for the interesting read.

[Phil Dumfee]

Deworsification is for losers. All billionaires are created by concentrating their investments all in on one pony.

[AUMmmmmm....mmm..mm.nnnn]

@Phil Dumfee
What are your chances of becoming a billionaire with a one stock portfolio?
On the other hand there are 22 million millionaires in the US.
I would venture to guess that most of them have maintained diversified portfolios.

[metoo5]

@AUMmmmmm....mmm..mm.nnnn - But you’re just projecting your own opinion on how things should be onto the world. Actual research would be required to know.

Back when The Millionaire Next Door was last revised, and unfortunately I don’t know how long that was, it was supposedly found most millionaires made their money not in the market at all but in their own businesses.

I think a lot of millionaires have since crashed the party who aren’t entrepreneurs and on the basis of their portfolios. There’s a book waiting to be written on that I suppose. My own guess would be that they’d be far more highly concentrated than the finadvisor industrial complex says is wise. But then I’m just projecting my own experiences Lol. At least the earlier generations were definitely highly concentrated, extremely so, but just not in equities but personal businesses.

[AUMmmmmm....mmm..mm.nnnn]

@metoo5
Yes projecting my own opinion again.
I always think more in terms of a retirement early goal rather than a need to be a certain type of .aire.
More time to do as you please.
And study the market each day.
One share at a time.
Buy or sell
Diversified portfolio
Amazing what you learn.
So little risk.
Why does one author ban me.
Or was it a technical glitch?

[Maverick 2021]

Own, don’t trade AAPL …!

With the Federal Reserve still buying bonds, AAPL growth was certain going forward….

$4 Trillion Dollars should be faster and stronger growth, as new products and services hit the deep pocketed consumers….

25 % growth is a great return, especially with stock buybacks, and all that cash on the balance sheet….

The Federal Reserve has near $9 Trillion Dollars floating around the financial system looking for a home and AAPL is a great place to park…!

[Shalabue]

Apple makes up over 50% of my portfolio. Im over 800% I did sell some in my IRA back when market hit a low due to Covid. I jumped into a number of dividend stocks.Like HD at a low Navidia J&J Abbott labs. So far up like 50% on all. I hesitated selling my cash account Apple for tax purposes and will draw as needed. I will stay Apple all the way to $200 when I might consider selling some more. It will be $200 by the second quarter of 2022......my prediction.

[Envision Research]

@Shalabue congrats for a successful investment! AAPL will get to $200. It is a matter of when.

[SemperVee]

Finally!! Somebody actually speaks about dealing with great profits in a taxable account!

[jakefountain]

AAPL is 40% of my portfolio. Sold more than half over the years starting with my IRA and then just enough so no tax implications. Problem is it just keeps going up.

I think you hit the nail on the head when you stated " In non-tax-sheltered accounts, your replacement ideas not only have to be better than AAPL, they have to be at least about 20% better to overcome the tax alone." That is the challenge.

[Envision Research]

@jakefountain yes. I have a hard time finding ideas that are 20% better than AAPL anyway myself when all risks are adjusted.

[awboat]

@jakefountain I just checked and apple is about 35% of my investments. I got in around $4.60 in 2007. That $4300 has turned into a lot. I have been selling apple out of my IRA to live on too and I still have over $150,000 of it. I guess I'll just keep doing the same thing. But I am also in more cash now than I have ever been before. This market scares the crap out of me.

[Jonatthan]

@jakefountain I wish I had the same problems you do
“It keeps going up”

[MiTreats1]

I appreciated your second conclusion point. 'Furthermore, to effectively diversify, you not only need uncorrelated stocks, but they need to be “good” too.'

When my portfolio achieved a certain, yet still modest, amount I was targeted by a few junior fund managers who appeared to be straight out of indoctrination. They urged me to diversify strictly for the sake of diversification and to evenly spread my account across all sectors regardless of their current or future prospects. This should seem ludicrous to anyone with a brain. To punish their portfolio returns simply because a few stocks or sectors are performing better than others. That isn't the true meaning of diversification.

[Envision Research]

@MiTreats1 thanks for your kinds words and for sharing!

[Felloni]

alternatively sell cash secured puts and covered calls staggered so you are always making theta

[Envision Research]

@Felloni yep. selling puts is a good strategy too. Just AAPL's implied volatility is a bit on the lower end. TSLA would a better candidate if someone sits (I bet plenty of people are) on a ton of unrealized gain.

[Felloni]

@Envision Research
Agreed...TSLA is also very liquid and the spreads are good. IV higher making short legs very attractive

[arete_builders]

A couple of thoughts:

1) 30% of the S&P 500 by weight is held in the top 10 largest holdings. Sort of proving the underlying thesis.

2) One of those Top 10 holdings is BRK, which is roughly 25% AAPL by market value. So your AAPL exposure in SPY is even higher than you think.

3) Those top 10 holdings include Amazon, Meta, Google, and Microsoft, all of which are still pretty high growth, even as mega caps. Really, out of the Top 10 holdings, the only ones that are clearly overvalued are Tesla & possibly NVIDIA. So I'm pretty open to the idea that the S&P might not be overvalued at 30x earnings (or whatever it is right now).

Weird time to be an investor.

[Envision Research]

@arete_builders yes, weird time to be an investor.

Although I want to do a bit of hair splitting - the valuation of "SP 500" is different from the valuation of "the market", precisely for the reasons you mentioned - the S&P 500 valuation is distorted by a few mega-cap and highly valued stocks like NVDA and TSLA.

So SP500 is highly valued but "the market" may not be - as long as you exclude these outliers.

[Maverick 2021]

The iPhone 5G super cycle is a joke, as the US carrier deployment of 5G is NO better than the current LTE networks….

You don’t need a 5G smartphone to run on the currently deployed LTE networks….

Stop buying an iPhone 13 for a 5G network that sucks !

[stockavenger]

@Maverick 2021 this isn't how it works.

We don't get to lecture the consumer on what they should or shouldn't buy.

We get to interpret what they are or are not buying.

People ARE buying iPhone 13.

It simply doesn't matter that you believe they shouldn't be.

[TurboRocker]

@Maverick 2021 - I agree with you that 5G mostly is not noticeably better than the LTE, so far.
However, if it sells, it sells.

Also, though 5G is the big advertisement push for the new phones, that is not the main reason for Apple's Iphone success. The main reason is that these phones are way better than the competition.

[metoo5]

@Maverick 2021 - As TurboRocker points out, advertising and purchase reasons very different things. It’s the analysts claiming or implying that people are upgrading iPhones to get 5G. But there’s no actual evidence of this to my knowledge and every reason to think it’s a myth.

Apple wisely ordinarily hates promoting a single feature over the iPhone as a holistic unit. They made an exception this time IMHO because the carriers who want to promote the myth that most people would find it worth upgrading solely to get 5G (they don’t) offered to throw Apple money in the form of iPhone subsidies, which does increase iPhone sales.

There’s no 5G supercycle. It’s a myth. There is the regular iPhone cycle-extraordinary in its own right-aided now to some degree by iPhone subsidies from 5G carriers and baseband IP companies who spawned the 5G supercycle myth. Money is money, Apple doesn’t care why analysts think people are upgrading as long as they do. But don’t worry, it’s a decided minority buying iPhones to get 5G. As far as a single feature, as opposed to just having a 2-3 year old iPhone, the camera is almost certainly a greater driver of upgrades than 5G.

[Jonatthan]

Why would you sell or diversify your apple stock ???
If you plan to diversify buy with new money other stuff you like
Apple is a gem and should be held
Until you need it
Or should be passed to your next generation like I want to do
I keep on buying often.
I don’t have the stomach to do 100% apple but I give props to the people that did it and I’m sure they are very happy they did
Happy new year to all

[arete_builders]

@Jonatthan LOL, I sold it out of my kids Coverdell at $122 or so last fall to pay tuition...turned out we didn't need to...and it shot up to $177. At least we didn't sell her brothers!

[Envision Research]

@arete_builders lol. this is time to remind ourselves that we did well enough already - after all, the kids are in college and paid for.

[Hank890]

Bogus nonsense
SA is generating too much rubbish lately

[Seeking more alpha than you]

@Hank890 I disagree and think SA does a great job.

[the pedestrian]

@Hank890 As nonsense, that is bad. As bogus nonsense, then that would be some sense.

[citikid]

@Hank890 , I disagree with “Bogus nonsense”. This was a well measured and thoughtful article with no ego or drama.
I do agree that SA is tolerating a good deal of rubbish though. But not this.

Maybe your reading style is more aligned with authors who pontificate;
“I am the way and the truth and the life. No one comes to alpha except through me.”

It is fun to read that stuff though.

[malinois000]

Very good article. Apple has grown to 16.1% of my after tax portfolio which is made up of 32 individual stocks and ETFs. I have been asking myself the Apple "trim" question for the past several months but have opted not to do so. Your article help me think through this issue.

[All*AAPL]

@malinois000 said:
===
" Apple has grown to 16.1% of my after tax portfolio which is made up of 32 individual stocks and ETFs. I have been asking myself the Apple "trim" question for the past several months but have opted not to do so."
===
***My wife and I have had a 100% AAPL portfolio for 20+ years...fears of AAPL dropping like the proverbial rock are overblown, IMO. If you continue to hold AAPL longterm, you'll be glad you did...but, obviously that's a decision only you can make.

Just don't let the AAPL fearmongers scare you into doing something you'll regret.

Good luck with whatever you decide to do! 😊

[jakefountain]

@All*AAPL So you have no ETF, CEF, 401K, Mutual funds or cash?

[Envision Research]

@malinois000 thanks for your kinds word and glad the article helps!

[HogMoney]

Funny, I had already planned to sell shares of Apple tomorrow out of our IRA as part of our Y2022 RMD. I still may, after I check out RSP and BRK.B, putting the $ into our taxable account until needed this year for travel. All part of the investment guessing game!

[berylrb]

@HogMoney I had that dilemma on Friday. But then I remembered that I held the equivalent shares in my Roth bought in 2016, so POOF problem disappeared.

I did not have a RMD I was leveraging funds for a real estate purchase.

[MiTreats1]

@berylrb Isn't a Roth IRA such a wonderful thing? No dividend or capital gains taxes ever! I already make more money in my Roth than I am allowed to contribute every year. A couple of times, like this year, I made more than I lifestyle spend in one year. My next goal is to make as much in my Roth in one year than I earn in one year. And no taxes!

[berylrb]

@MiTreats1 Right on! I retired when I was 58, 62 now, at that time my 5-year average total return was more than I made, and dividends were more than my take home pay.

But it was combined Traditional and Roth, awesome that you can pay the bills Roth only!

In my case, my wife still wanted to work as she was working on IP stuff, ... So eventually after trying the world of consulting and coaching I pulled the plug, took the plunge, and today it's just me and a puppy, which is a FT retirement job in itself.

[rcwahlert]

A deeper discussion of diversification should include geographic diversification of AAPL vs alternatives for both supply chain and end markets. AAPL has higher China-specific risks (maybe triggered by a Taiwan crisis) than some investments if one’s due diligence ID’s this as a 2022 concern. I have a stop loss under 1/2 my LT AAPL holdings with this in mind.

[md10]

@rcwahlert i agree. a lot of aapl's growth depends on continued
success in china, and that is not a sure bet.

[Envision Research]

@rcwahlert thanks for brining up the geo-political aspects of diversification.

Do you mind sharing more insights on how to quantify such aspects?

[rcwahlert]

@Envision Research In reply to your question re quantifying China risk for AAPL consider this “what if” scenario: China invades Taiwan. US & allies embargo all China trade. In the above the overall market could drop 25-35% overnight, but AAPL & stocks highly tied to China & Taiwan supply chain and end market could drop double this %. An investor flight to safety (cash, domestic centric stocks) results. If above is a realistic 2022 risk, using options or stop loss can mitigate AAPL risk