“Numerically, 1% of all humans on Earth bought an iPhone in Q4.” - David Ulevitchv, founder of OpenDNS
We don’t typically invest in individual stocks or bonds unless the value proposition is so compelling that we feel almost a sense of obligation to pull the trigger. Several months ago we wrote about such an opportunity in the triple net lease REIT space, and a little over two years ago we published a post explaining why we were bullish on the stock everyone loved to hate…Apple (AAPL). Today we will revisit our original thesis, review what Apple has done over the past two years, and look at what the future might hold for the company.
Back in January of 2012, Apple dominated the news after shedding over $200 billion in value due to its fall from grace in eyes of the investment community. People feared that the post-Steve Jobs Apple had lost its innovative spirit and was destined to lose significant market share to rivals such as Samsung who were pushing “the next big thing.” Our thesis for investing was simple, Apple sat on a mountain of cash accounting for over a fifth of its market cap, was the most profitable company in the world, and still had plenty of markets it hadn’t fully saturated with its existing technology. The quote from Slate.com writer Farhad Manjoo we used to open up our first post on Apple summed up our sentiments perfectly.
…the market attitude towards Apple seems unmoored from its actual performance. Apple is still the most spectacularly well-performing firm in the tech industry. Now it just needs to find a way to prove it besides monster sales and monster profits.
At the time of our post, Apple was coming off a quarter where they had generated $13.1 billion in profits on revenues of $54.5 billion with record sales of 47.8 million iPhones, in addition to other products, from October through December of 2012. The market was unimpressed and Apple’s stock plunged more than 12% on the news providing us with our first entry point into the stock. The negative sentiment toward Apple continued pushing the stock price down to a split adjusted value of just above $55 per share where we were lucky enough to purchase additional shares (bottom ticking any stock is 99% luck) within a couple percentage points of the absolute bottom.
Over the past two years Apple has figured out ways to build shareholder value through creative financing of stock repurchases and dividends as well as acquisitions, the largest of which being the purchase of Beats Electronics for $3 billion in August of 2014. Additionally, they have continued to expand their products into newer, relatively unpenetrated markets, refresh the product cycle on the iPhone, and announce new products with Apple pay and the iWatch. For the most recent quarter, Apple announced $18.0 billion in profits on a record breaking $74.6 billion in sales with 74.5 iPhones sold from October through December of last year. Apple’s shareholders have been handsomely rewarded over the past two years dramatically outperforming the broader US stock market.
We no longer hear people talk about Samsung eating Apple’s lunch or the fact that Apple can’t innovate, which we find somewhat amusing since Apple hasn’t really innovated much over the past two years. The new features in their existing products (larger screen for the iPhone) and new products (iWatch, Apple Pay) have already been brought to market in some form or fashion by Apple’s competitors. But this gets to the heart of why we like Apple so much. Apple doesn’t have to innovate, although they may in the future, to remain relevant and be a good investment. Apple has earned the trust and dare I say devotion of tens of millions of people worldwide due to their image and long history of producing top quality and visually appealing products. Apple simply has to continue making this fan base happy and in doing so, continue adding to the number of devoted followers every year.
Perhaps the best way to explain the difference between an Apple devotee and that of a “generic electronics consumer” is to compare the sales and profitability of Apple versus Samsung last quarter. Apple and Samsung sold the same, record breaking number of phones last quarter but Apple was able to charge over 3 times as much for their phones leading to a much greater profit than Samsung. Apples’ long history of doing things right and building a loyal fan base means their current business is much more profitable than any of their closest competitors.
So where does that leave us today? Apple is now the largest company in the world with a market cap approaching $775 billion. It trades at a trailing price to earnings (P/E) ratio of just under 18, which is significantly higher than the nadir value of 10 it traded at during the peak of Apple pessimism two years ago, but still lower than the 22 level it hovered around as recent as 2010. Many have stipulated that the sheer size of Apple will preclude it from being able to generate market beating returns for its shareholders due to the law of large numbers. There is some merit in this argument, but how large can Apple grow until it reaches that level? Just because it is the largest company in the world today, doesn’t mean it can’t continue to grow larger. In fact, when we look back through history and compare Apple’s current market cap on an inflation adjusted basis to peak market caps of other prominent companies, we see that there might be quite a bit of runway left for Apple to grow.
All this to say, buying Apple’s stock today isn’t nearly the slam dunk it appeared to be two years ago. The stock seems to be fairly valued (even though some prominent hedge fund managers would argue to the contrary), they are currently in the peak of their profitability cycle with the recent iPhone 6 release, and investors have a fairly positive view/outlook on the stock. For these reasons, we wouldn’t fault anyone for potentially swapping their Apple shares for a more diversified index fund like SPY or ACWI. That being said, we are content to hold onto our Apple shares for the time being as the company continues to grow, remains highly profitable, and has a best of breed management team in place to help navigate the largest company in the world to even higher highs.
Author Elliott Orsillo, CFA is a founding member of Season Investments and serves on the investment committee overseeing the management of client assets. He spent nearly ten years as a financial analyst and portfolio manager working primarily with institutional clients prior to co-founding Season Investments. Elliott earned a bachelor's degree in Engineering from Oral Roberts University and a master's degree from Stanford University in Management Science & Engineering with an emphasis in Finance. Elliott and his wife Gigi have three children and like to spend their time outdoors enjoying everything the great state of Colorado has to offer.
Transparency is one of the defining characteristics of our firm. As such, it is our goal to communicate with our clients frequently and in a straightforward way about what we are doing in their portfolios and why. This information is not to be construed as an offer to sell or the solicitation of an offer to buy any securities. It represents only the opinions of Season Investments. Any views expressed are provided for informational purposes only and should not be construed as an offer, an endorsement, or inducement to invest.