Weekend Investor: A Realistic Look At Apple Plus Lessons Learned
It’s not a good time to be an Apple investor right now. It may be a good time to become an Apple investor. If you are an experienced investor, you likely will get excited when quality companies are sold off, especially for what may be dubious reasons. Since the stock is damaged, you can sit back and take the time to perform a good analysis. You will have time to establish a position, maybe for even lower prices.
The question is, what is the bull case for Apple today, if any? I’m going to look at Apple not how the typical Wall Street analyst or mainstream financial writer looks at it, but as a value investor would who is interested in owning a great business.
First, Some Lessons
The calamity of the free fall in Apple’s shares demonstrates some important investing lessons. Even though I have been investing for a while, I continue to learn new things. Here are a few things that can be learned from Apple’s decline that will be useful in the future.
- High Stock Price Doesn’t Mean Expensive
There are many investors out there, surprisingly including some professionals who believe that a high stock price means that Apple is expensive. Most stocks are periodically adjusted through stock splits to attain a sweet spot price of $30-50/share. If a share price goes to $500, that by itself doesn’t say anything about how expensive the shares are. You need to consider the price in relation to the earnings and earnings growth.
Many companies today are adopting the Buffett convention of not splitting their stock. Not only Apple, but Google (GOOG), Markel (MKL) and others are resisting. In some cases splitting stock can add stock holder value with companies such as Southside Bancshares (SBSI) split their stock as an annual event to provide earnings reinvestment. But the vast majority are simply mechanisms to slice up the pie smaller without providing any additional shareholder value.
- Apple Is Over Owned
There have been a few red flags about Apple that have appeared recently. First, I read stories about funds that own Apple simply because it was going up; e.g., a small cap fund that has no basis for investing in a large cap stock. Apple was over owned by investors who have no real stake in the company’s story or business; they were simply going along for the ride. This is not a uncommon story with pure growth companies that attract momentum investors and traders.
The lesson is beware of these technical situations, because these types of investors will flake off easily. It is far easier to make money in stocks that have great growth stories that are under-owned, e.g., Kinder Morgan (KMI) and its related stocks.
- Watch Analyst Earnings Trend (EPS)
The consensus view of Apple’s earnings over the last 3 months was that earnings estimates were going down. The key here is not to make an assessment about whether they were right or wrong (I would be skeptical of analysts by definition – see below). There are investors who use this information to determine what position they will take on a company. Even if you think they are wrong, don’t fight the market. Don’t catch a falling knife. Wait for a possible pull-back to establish your position. You need to follow these estimates closely for the stocks you own.
- Analysts Are (Almost) Useless
Analysts who cover stocks and offer opinions and analysis need to be put into the proper perspective. As I mentioned above, analyst estimates can sometimes provide benefit since a very large consensus opinion that develops can in fact move the needle in investor sentiment and action. But, the problem with analysts is demonstrated by bias, conflicts of interest, and herding mentality (jumping on the bandwagon of a trend started by smarter money). Analyst reports are still useful as a source of information but it’s a stretch to use this information solely for buying, holding or selling decisions.
If you read analyst reports by the major investment houses for a company, you will find that they provide analysis of a company using financial and industry comparisons. Surprisingly, they will typically add a ‘momentum component’ to the analysis. So, what this means is that they believe the wisdom of the recent price action will foretell the future (following the herd) . There isn’t much qualitative analysis here, to help you determine if the business is good and has good management.
Apple, The Next Berkshire?
Once you become an adult you inevitably will look for leaders, athletes, products, etc that meet some standard that you grew up with. I find myself surprised that I sometimes yearn for what I perceive to be better days from the past. Logically, though, life moves forward, and those great things from the past do appear they are just different in unimagined ways.
It’s unlikely that another investor like Warren Buffett will appear again. But how he manages his business and invests are useful as tools to find other good investments. To sum up Berkshire Hathaway: they take large moat, high margin businesses and use the profits to buy more businesses. BRK.A started out as an actual business, but it became something larger because the large profits were used to become a much larger holding company. The business became incidental to the goals of the larger company.
To demonstrate this difference with an example, you may have read that Berkshire Hathaway recently fired the executives at Benjamin Moore (paint maker), its wholly owned subsidiary. The reason? The executives at Benjamin Moore wanted to reinvent the business by going into the higher volume big box stores to sell paint. BRK.A stopped this expansion because their goal isn’t to be the largest painter seller, but a very profitable one at whatever size that means. Higher volume == Lower margins == lower profits.
Apple similarly looks to make the most money and not necessarily be number 1.
The question is about Apple: is the business becoming incidental to its profits? Apple reported $137B of cash and investments on its balance sheet, it went up about $15B last quarter. There is nothing indicating that they will not continue to add 10s of billions of dollars every quarter for the foreseeable future. Their larger selling products showed a lot of growth this quarter (50% for iPads), though it remains to be seen if Apple can sustain high margins. Even if they don’t improve the margins, the cash horde will continue to grow.
What’s Next For Apple
We have never seen a company like Apple before, a company with arguably a good sized moat (larger than they get credit for) and such huge profits at a scale so large. What will become of all their retained cash horde? If you buy Apple today, it is likely you will own an investment in 5 years that will have enough cash to buy back all its shares. They could simply go out of business and make every shareholder a hedge fund investor.
The exciting thing about this, is that it is early to call for the demise of PCs, iPads and iPhones. These technologies are just getting started (iPad is less than 3 years old). Forget about Apple having a trillion dollar valuation, how about a trillion dollars of cash on hand? It is possible.
So far Apple has been a good steward for investors. Unlike other technology companies, they haven’t made major acquisitions that blew up, or perhaps didn’t make any sense. The balance sheet has no debt, and they don’t make products unless they have a quality and competitive advantage that offers a high margin possibility.
It will be interesting whatever happens