How Cheap is Apple?

Apple, the stock and the company, is everything but not typical

Most momentum stocks go through 3 main stages:

1) Earnings growth leads price growth. There is sudden acceleration in earnings growth that starts a process of repricing, but most investors are still cautious with the new name. They either don’t trust the sustainability of the story yet or haven’t heard about it. This period could continue anywhere from 6 months to 2 years. (think in terms of Hansen Natural in 2004 – 2005)

2) Price growth leads Earnings growth. At this stage the stock and its story are widely known and understood. The market projects the current levels of growth into infinity and it proactively discounts the best case scenario. This stage typically continues anywhere from 6  to 18 months. (think in terms of $MNST in 2006 – 2007 or $NFLX mid 2010 to mid 2011)

3) Either price growth and earnings growth start to go hand in hand or price growth drops below earnings growth ( as it is often the situation with ex- momentum leaders)

As you can see from the chart above, $AAPL is not following this pattern. While its market cap has increased 46 times for the past 10 years, its earnings per share growth has been even more impressive – 130 times. The EPS growth was offset by a 60% decline in the P/E multiple that the market is willing to pay. P/E often reflects investors’ expectations for near-term growth. As Nicholas Darvas liked to point out:

It is the anticipation of growth rather than the growth itself that leads to great profits in growth stocks. The biggest factor in stock prices is the lure of future earnings. The dream of the future is what excites people, not the reality

Walmart’s shareholders have experienced that personally. Over the past 10 years, $WMT’s EPS have more than doubled, while the market cap of the giant retailer fell 21%

The law of big numbers’ effect is commonly known and it is already discounted

For more than three years, investors have been pointing out that the gigantic size of Apple will limit the pace of its growth. Apple has proved them wrong, but Apple has been an exception. Historically, size has been an enemy of fast growth. Eventually, the naysayers will be right, but this might not matter.

Everyone and his grandmother has heard of this thesis and it is already discounted by the market in some form. How else would you explain the fact that $AAPL is trading at 15 times P/E while it is growing its earnings at 50%. The market clearly anticipates slowdown in earnings and if there is a surprise, it is likely to be on the upside.

Should Apple Pay Dividends – Not Today

There have been many discussions lately about the money hoarding by the big U.S. tech companies. The common denominator is that $AAPL  and $GOOG should start paying dividends. At this point, this suggestion is ill-advised and doesn’t make any sense.

Apple’s current ROE is 41%, which means that it makes 41 cents for every $1 of its capital. Logic says that if Apple’s shareholders cannot find an investment with higher than 41% return, they should not want to get paid dividends. Apple is still using their capital wisely.

Expectations Going Forward

Over the past few quarters, it has become a tradition  for $AAPL to appreciate in front of its earnings report, reflecting general expectations for positive surprise. The price action after the report hasn’t been that inspiring as “buy the rumor, sell the news” effect has dominated. I don’t expect this quarter to be any different, but anything is possible.

Disclosure: At this point of time, I don’t have a position in $AAPL

Embrace the Uncertainty

There are two types of forecasts – lucky and wrong.

Acting like you know everything is more dangerous than accepting your limitations.

Macro forecasting is not critical for investment success.

The only constants in capital markets are change and uncertainty

Being on the crossroad between the risk of losing money and the risk of losing opportunities

These are some of the tidbits from Howard Marks’s latest investors letter, which is among my favorite reads. There is always something insightful to learn.

Oak Tree

13 Signs of a Bull Market

1)      The market reacts positively to bad news. Negative headlines and terrible earnings reports are ignored. As the saying goes, reaction to news is more important than the news itself. Good reaction to bad news is the ultimate indicator of positive sentiment. Never underestimate the power of optimism in the market – it feeds on itself and creates positive feedback loop.

2)      Plethora of high-volume breakouts to major new highs, representing different industry groups. The so called “market of stocks” environment.

3)      Low correlation market, which produces both winners and losers. There are good ideas for both bulls and bears.

4)      Defensive sectors underperform. Capital leaves perceived safety and rotates into more economically sensitive sectors.

5)      High beta names outperform as the fear of missing out becomes higher than the fear of losing. Small caps, emerging markets, low priced stocks outperform.

6)      The financial blogosphere will be filled with skepticism. Six months of trend-less , volatile market that was dominated by mean-reversion could certainly condition even the most experienced market participants to be extremely cautious with new breakouts. The rule of thumb is that during pronounced uptrends, there will always be people who will complain that the market is overbought and warn for an impending correction. As Schopenhauer stated long time ago: ““Every truth passes through three stages before it is recognized: In the first it is ridiculed; in the second it is opposed; in the third it is regarded as self-evident.”

7)      There are so many breakouts that you are confused which ones to take. You feel like a kid in a candy store or like an adult in front of a cheese stand with 200 options to choose from. This is normal – the human brain is meant to operate in an environment of scarcity. To cope with a situation like this, we have invented shortcuts that mean different things for different people. Technical analysis is one form of a short cut.

8)      Breakouts stick and have a follow through.

9)      Most of the dips you buy, turn out profitable.

10)   Major market indexes are trading above their rising 50dma. The moving averages are typically lagging indicators, but they often play the role of a good point of reference.

11)   Market indexes are rising on increasing volume. The pullbacks are on lower volume

12)   People ask why such and such stock is up 15% today on now news. Sometimes the only news you need is the lack of bad news. Positive sentiment and money flow are powerful catalysts that could continue longer than most expect and have bigger impact than most are willing to comprehend.

13)   Your confidence increases substantially and you honestly believe that you are the best trader in the world. Don’t confuse brains with market uptrend. Overconfidence is the single biggest reason for investors’ demise. The second biggest reason is ignorance, but this is a topic of another conversation.

 

No matter the market environment you trade in, paying attention to risk management is of utmost importance. You don’t have to be right, you don’t have to be original, you don’t have to be first, but you have to take favorable risk to reward trades. If you don’t have a plan, you will become part of someone else’s plan.

I know 13 is an odd number, but this is all I could come up with at this point. Add yours in the comment section, if you will.