I’ve been an Apple Bull for years, but I’m starting to appreciate the reason for reducing the long position to current levels.
The P / E is higher than it was in the 2007-2010 mega-growth period.
In fact, the PEG is about three times richer than it was 10 to 12 years ago.
My fears go beyond assessments, as the predicted catalysts are about to materialize and soon become “old news”.
The equity portfolios have probably become too heavily attributed to Apple.
This might be a good time to move the exhibit.
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Let’s be clear: I’m an Apple Bull (AAPL) and have been for years.
For the reasons I will list below, I believe that stock deserves to be part of any investor’s diversified equity portfolio.
However, I think taking a particular inventory shouldn’t be “going back” or “running for the hills”. I, for example, have a more nuanced perspective on Apple. While the stock will likely continue to rise for a period of several years, I also think this may be a good time to consider if a portfolio might be over-allocated to that name.
Credit: Bay Nature background image
A quick note on buying and owning Apple
I could go into more detail on why buying and owning Apple shares might make sense today. Some of the reasons I have previously used to support my uptrend include things like:
The next round of 5G upgrade that could bring a mature smartphone company to life, albeit temporarily;
Further expansion of Apple’s more predictable, higher-margin service segment;
The success of a portable segment that just a few years ago would have confidently predicted to be the growth engine it has become;
Catalysts in VR and AR that have not yet taken place in a meaningful way and that could lead to the rise from the end of next year;
Apple’s large sum of money which I said could easily be used to double the company’s dividend payments or be distributed in several other ways to unlock value.
Let me add a layer to the discussion by looking at the historical development of prices.
Since Apple’s IPO in 1980, investors who bought stocks any time of the month and held them for exactly five years, regardless of price points or valuations, have gained more than 10% per year (i.e. higher market returns) about two-thirds of the time.
In only 7% of cases, buy and hold investors produced five-year losses of -10% per year or worse.
These rare cases coincided with Apple’s near bankruptcy years in the 1990s, a thought that would hardly cross the minds of Apple shareholders today. See the five-year yield distribution histogram below.
Source: DM Martins Research, Yahoo Finance data
Case of the bear of a bull: notes
With that said, let’s take a look at the downside.
Apple shares have risen 150% in the past year, even in times of a global pandemic and in the face of a potentially deep and painful global recession. The last time the stock rose this much in a 12 month period was in 2010. Remember that at the time (1) the economy had just started to recover from the recession 2008-2009 and (2) Apple was enjoying golden years of growth thanks to its two new product categories, iPhone and iPad.
From a final P / E perspective, Apple’s
valuation around June 2020 was as high as it was 10 years ago (see first chart below). However, as a result of the company’s third quarter profit plummet, the multiple has risen to almost 40 times today. These levels haven’t been seen since 2007, the year before the Great Recession which also marked the historic debut of the iPhone.
When I put the P / E into perspective for earnings growth, the valuation picture looks even more ominous.
Check out the second graph below and ignore the distraction spikes caused in large part by momentary fluctuations in BPA. The PEG is now above 3.0x, which is not a 2020 high. However, the growth-adjusted P / E ratio is now about three times richer than the multiple ever reached in 2007 or 2010.
The company’s strong fiscal third quarter was supported by increased demand for Apple products during the pandemic. Securing meant more iPads and Macs were needed, and these are precisely the two product categories that have performed the best in the most recent period (see graph below). The favorable winds of work and home study are unlikely to end entirely, but they could abate somewhat. Keep in mind that buying tech devices is done in waves and updates are usually not needed for 1 to 3 years on average.
Apple has grown nearly 10% in the past two weeks alone on less than positive news, and I have to assume that the 4-to-1 division must have played a role in boosting investor sentiment and fueling the momentum. The split will be “old news” from Monday August 31st.
Source: DM Martins Research, Company Results Report data
Correcting a distortion
Due to the recent strength in the share price, a distortion seems to have occurred: the equity portfolios have probably become too heavily allocated to Apple. One of the best examples that comes to mind is the Dow Jones Industrial Average (DIA).
I would like to emphasize the term “industrial” in the name of the index. Despite this misleading branding, Apple (a tech and consumer discretionary company) makes up over 12% of the Dow 30 portfolio, not much less than all the other tech names combined. That number compares to an allocation of just 4.5% in 2015, when Apple was first added to the Dow Jones.
Source: DM Martins Research, Vanguard data
In my SRG All-Equities portfolio, AAPL is still a big piece of the pie, one of the top three stocks, in fact. However, I made the decision early last week to reduce my exposure to the Cupertino company a bit while the stock still has a big lead. I suggest other investors ask themselves if they should do the same with their portfolios.
Beat the Mile Market
AAPL is part of my All-Equities Storm-Resistant Growth portfolio. Other mega-cap names helped produce outsized gains, which were a mile better than the S&P 500 (see chart below, pink line).
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