No. of Recommendations: 8
Hi everyone,

As you know, the MUE port (along with a lot of other people) owns a few shares of Apple. Six, to be precise. :-)


Date Basis # Gain vs. S&P 500
6/21/11 $328.62 1 sh 34.60% 15.16%
7/27/11 395.37 1 sh 11.87% ( 6.52%)
8/26/11 371.36 1 sh 19.11% (11.96%)
2/27/12 525.70 1 sh (15.86%) (27.30%)
12/17/12 511.94 2 sh (13.60%) (18.35%)

Total: $441.66 6 sh 0.15%


All data as of last night's close.

At one point, it was one of my better winners overall, but is now, essentially flat.

The question I've been debating with myself and others is whether I should sell, hold, or buy. Actually, I probably won't buy at the moment because I'm already maxed out on the holding size I'm letting myself have in the MUE port at 6.5% of total investable funds. Maybe I could squeeze in one more share (which would bring it up to 7.5%). We'll see.


What I'd like to share is some of the thinking I've been doing regarding Apple, arguing this point back and forth. Some of this was part of a recent discussion elsewhere, while some of this is original here. Some of this is from before Apple release earnings a couple of weeks ago, some of it is from after that event.


Let's talk moats.

AAPL -- Not very deep or wide. Android phones can do what iPhones can and Samsung is quite a competitor. Apple may have the market share lead here in the U.S. (something it's supposed to have regained (note the "re" part) recently), but it's way behind worldwide and that's where growth is supposed to come from. iPod sales are in a seemingly permanent decline. And with tablets, Microsoft is making some seriously compelling ads hyping the coolness of the Surface. And then there's all the Kindle flavors, which basically forced Apple to come out with the iPad Mini -- responding rather than leading.

Nokia was the undisputed leader of cellphones until competition caught up and ate its lunch to the point where the survival of the company came into question -- and it had an extremely strong balance sheet at the time, the same argument being made for Apple. If I recall, Nokia was among the last to adopt the flip / clamshell style of cell phone, which replaced the soap bar style from before that. Apple today reminds me of Nokia then.

Everyone seems to be making the argument that Apple shares are cheap, but if that's the case, why the heck doesn't the market recognize that? The market may be inefficient in some instances, but not most of the time (I'm with the camp that it's "mostly" efficient). So, is the market's price accurate? I'm afraid it could very well be.


If sales growth slowed down:
I would suspect that a deceleration of growth from a market-growth-beating level of near 60% to a merely-market-matching level of 30% would not be viewed favorably by the stock market.


Competing on price someday?
I’m worried that "someday" is coming a lot sooner than any of us hope. And I certainly don’t want to see Apple shares do what Microsoft’s have done over the past decade (another company that has and had a very strong balance sheet, paid a dividend, and generated tons of cash flow – just like the Apple of today).

I’m not saying that Apple won’t be a long-term success. I’m just worried that history may be rhyming with this company. (Referring to Twain’s comment, "History does not repeat itself, but it does rhyme.")


<Q1 2013 Earnings released>

Well, with Apple's disappointing results last night, some of my fears are coming to pass.

I had a long conversation with David Meier, another analyst here at TMF, about Apple yesterday before earnings and he and I have pretty much come to the same conclusion. We both see the most likely scenario as the shares staying pretty flat for the next 1 - 3 years, until, at least, Apple can prove to the market that it can indeed innovate again, sell more and more, gain share, and all that. There's a chance that it could move significantly upward if it can do that fairly soon. There's also a chance that it could move significantly downward if the company completely loses it -- if it cannot innovate well enough, if it is perceived to be responding rather than leading (and it has been already with the iPad Mini), if market share drops, if margins contract even more, etc.

There is no doubt that on a fundamental basis, Apple is currently pretty cheap. But that doesn't matter at the moment. Everyone in the world can and does see that, yet the price has fallen almost 30% from its high (where it was still relatively cheap) to last night's close.

No, what matters is what Apple will do over the next few years. This is a perception issue. ... Right now, the perception is against Apple and I don't believe it will be changing any time soon.


The MUE port invests based on perception, on expectation. When the market's perception of a company is negative, it drives the share price down until something happens to reverse that viewpoint, letting the share price come back up. Activision Blizzard's share price has remained flat for several years partly because of perception, regardless of the very good results the company has produced. I think that the odds are high that something similar will happen with Apple's share price, at least for a while because I think the market's perception is pretty accurate right now (it's one of the most heavily followed stocks and companies on the planet). Certainly until Apple can show that it deserves excitement again. So I believe the share price is likely to remain flat for a while.

On the other hand, if Apple's margins continue to erode, it releases a major flop of a product, it starts trailing others on innovation, then the share price could fall again. Just because it is "cheap" from many valuation viewpoints doesn't mean it cannot get cheaper. In the short run, the price is about perception and assessment of future earnings and growth. If the company stumbles around for a bit, that perception will decline, as will the share price.

The MUE port is about messed-up expectations and taking advantage of them. Right now, I don't think the market's expectations are completely messed up, so I'm going to hold off buying more.

I'm also not going to sell, as I believe the chances of the company's share price appreciating again are pretty good. Looking back, it was probably a poor decision process not to sell when shares were in the mid-$600 range. There was a lot of froth and rah-rah everywhere about the company. While the numbers for FCF expectations didn't get very high (certainly no higher than the company's delivered in the past few years), the feeling surrounding the company got heated. When "everyone" loves a company, it's probably time to start looking for the exit.

Now, it's probably going to take a couple of years until the market again loves Apple (assuming that Apple earns that love) and I'll end up sitting on the shares that long. If I needed the money to invest in other ideas, then I'd probably sell. However, I continue to receive monthly infusions of cash from TMF, so I have plenty of cash to invest without touching the Apple shares. Right now the portfolio is at 14.4% cash (based on current portfolio value), and I need to trim that down to about 10% or so, while at the same time receiving more cash at the beginning of each month.

Cheers,
Jim
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The MUE port is about messed-up expectations and taking advantage of them. Right now, I don't think the market's expectations are completely messed up, so I'm going to hold off buying more.

Hi Jim,

Using your reverse DFCF model, what are the market's expectations for Apple right now?

Thanks,
Fletch
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No. of Recommendations: 4
Using your reverse DFCF model, what are the market's expectations for Apple right now?

Hi Fletch,

Using last night's closing price of $457.84, TTM FCF of $47,437 MM, and a 15% discount rate, the current priced in expectations for growth to justify that price are 6.3% / 3.2% / 0% (1-5 years / 6-10 years / then on).

Historically, the company has grown FCF by 15.9% over the past year, 63.7% CAGR for 3 years, 53.2% CAGR for 5 years.


More data points:

Of the four value points James Montier points out (earnings yield at least equal to twice AAA bond yields, dividend yield at least 67% of AAA bond yields, total debt less than 2/3 tangible book value, 10-year PE no more than 16), it fails on the last point, with a 10-year PE (that is, today's price divided by the average of the last 10 years of earnings) of 36.6.

It has a P/S multiple of 2.6, which I feel is a bit on the high side (prefer to see less than 2 when considering a purchase).

It has a Piotroski score of 4 out of 9 (higher is better), failing with a decline in ROA, a decline in the current ratio, equity issuance, drop in gross margins, and drop in asset turnover.

Cheers,
Jim
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