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Mitch Feierstein

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Hey, There's a Worm in the Apple (Inc.)

Posted: 07/26/2012 5:39 pm

Back in April, I wrote a piece about Apple Inc. I suggested that the company's stock price was a little frothy. I suggested caution was in order. At time of writing that piece, the company's stock price was at about $635, just a shade off its high.

I got crucified for that piece. Virtually everyone commenting said that my comparisons were inappropriate, that I couldn't possibly own the company's products, that I didn't understand the company's value-drivers. The consensus of opinion was that investors should continue to add, with caution, to their portfolios. Since that discussion, the company's stock price dropped around $100 in a matter of weeks, before recovering some of the lost ground since.

And my view hasn't changed. For the sake of absolute clarity, let me repeat what I said last time. I love this company. I love its products. I own the lot: iPhone, MacBook Pro, iPad, iPod. This company is so good that they could come up with pretty much any three letter word, stick an i in front of it, and I'd be in the line to buy it, whatever it was. If Apple produced a cheese grater, it would be the best cheese grater in the world.

But you need to put those things to one side when considering your stock portfolio. You need to operate with reason, not adoration.

First, let's consider the general background to this stock. It's up almost 8,000 percent since December 1995. If you look at the most recent trading data, you can see the price has gone parabolic. On a curve that points upwards at infinity. And simple market experience tells me that these things never last. The dotcom boom didn't. The housing boom didn't. This Apple boom won't either. Markets are apt to vicious corrections and overcorrections. They happen most of all when the parabola looks most enticing.

And then again, think of the economic background. Europe is rapidly approaching a debt meltdown. We're approaching our own fiscal cliff. No matter who comes into office this winter, we're about to enter a period of much needed fiscal austerity which will surely threaten the U.S. economy with renewed recession. (Or worse: I think an extended depression the most likely outcome.) At times like these, equity ratings should be cautious, not bullish. Apple's rating is still sunnily optimistic.

It's also worth thinking of the fragility of our financial markets generally. The federal government currently borrows ten-year money at 1.42 percent. Our government debt is rapidly approaching the levels last seen at the end of World War II. We have no plan for regaining control over the budget. The Fed has exhausted every tool of monetary policy and has, indeed, risked creating a huge inflationary problem down the road.

The truth is that 1.42 percent is an insanely low yield for a borrower in the shape that the government is in today. Sooner or later, the government bond market will correct (it would do so much faster if the Fed stood back) and there will be an inevitable rebound on to equities.

So much for the general argument. The specifics on Apple are no more cheering. Analysts expected third quarter revenues to come in at $37 billion; they came in at $35 billion. The miss on earnings was even worse: analysts had penciled in $10.36 a share, and the outcome was more than a dollar per share worse than that at $9.32.

Sales of iPods fell. Sales of Macs were flat. Sales of iPhones were up on the year, but sharply down on the prior quarter. Sales of tablets were excellent, but the competitive background is changing fast. The new iPhone is great, but it's not a game-changer the way the first one was. It's kind of like the Rocky films. Rocky 15 just won't lift the heart the way the very first one did.

Now at this point, I should probably reiterate what I said at the start. I love this company's products. I think the company that Jobs built is the most impressive American company to have emerged since the days of Ford and General Electric. But those judgments are different from judgments about valuation. The results just announced are not the results of a gravity-defying company, but of one governed by the same laws of competition that everyone else faces too.

People haven't got bored of smart phones or of anything else that Apple makes. But sometimes, as an investor, you have to stand back and ask, really? And the question here is really twofold. One, can Apple's top line growth continue when its markets are becoming relentlessly competitive? Two, can Apple's near 40 percent operating margin persist when every big electronics and Internet company on the planet is out to steal the firm's lunch?

The correct answer to both questions is no. I go on believing that Apple is as good as a company can get. I love its products. But Apple's boosters have forgotten the laws of competition, which say that you can run ahead of the pack for a while, but not for ever. The economic and financial background is heinous. Apple's ascent has been parabolic. And the firm now has a raft of competitors which are starting to look lean, sharp and switched on. The stock has fallen a further 6 percent since the company announced its results, but the fall has a good way further to go yet.

 
 
 

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