08 Mar The Lato Letter : Volume 1, Issue 8.
You certainly cannot pick up a newspaper or magazine or watch any business channel without being inundated with stories about Apple and the news surrounding its product announcement yesterday. Normally when an investing subject dominates the press, it is a sign that the prevailing trend, whether positive or negative, is about to reverse.
At the sake of using an investment cliché that has buried many who have uttered it in the past, I will say “it is different this time”. Apple has been a savior to clients’ portfolios over the last six years having increased almost nine-fold since its initial purchase for clients in mid-2006. The position has been trimmed several times since then (including earlier this week) but it remains the single largest holding in clients’ portfolios. I continue to feel that the list of reasons of why “it is different this time” is long and powerful.
This list of reasons includes the following:
1) The valuation remains very low for a company with this growth profile. At its current market price of $535, Apple is trading at a Price/Earnings (P/E) multiple of 12.5 X the consensus estimate for the fiscal year ending September 30, 2012 and 11.3 X fiscal 2013 estimates. Stripping out the almost $100 per share of cash, brings those P/E multiples down to 10.2 X and 9.2 X respectively.
2) The company’s products are universally regarded as the premier products in the four major categories it participates in: portable music devices, personal computers, smartphones and tablets. It dominates two of those markets (portable music devices and tablets) with the tablet market being one of the fastest growing consumer markets out there. In the other two markets, considering smartphones as a subset of the overall mobile phone market, Apple’s market share is still relatively small and particularly in the personal computer has significant room to grow. With an iMac desktop, a MacBook, a MacBook Air, two iPads and two iPhones in the Lato household we are certainly believers in their products and are not alone in moving in that direction.
3) A recent report by JP Morgan discusses the relative underweighting of Apple in many institutional portfolios. Quoting from that report as an example, “Of the 282 mutual funds indexed to the Russell 1000 index, a surprising 40% do not have Apple as a Top Ten holding.” This relative underweighting suggests that there is still potential for more buying power to come.
4) There has been much discussion of the potential usage of that $100 per share of cash mentioned earlier. One of the obvious uses would be the initiation of a dividend. (Update: To see my BNN appearance about Apple’s initiation of a dividend on March 19th please click here.) In addition to returning capital that is currently earning a low return to shareholders, the initiation of a dividend would broaden the potential shareholder base to include those institutions that are currently precluded by their investment mandates from purchasing Apple because it does not pay a dividend. A research report today from BMO Capital Markets suggests that funds with an income fund alone could potentially purchase up to 4% of the current market cap if Apple were to declare a dividend.
As with any holding, there are risks and Apple is not immune to risks. It obviously can be impacted by a slowing global economy and/or declining equity markets. Other risks include increased competition, which can suppress margins, new technologies which can leap frog their products just as the iPhone and iPad leapfrogged their competitors, and eventual market saturation (as seen in the iPod) which slows the growth rate of revenues and earnings.
All things considered though, the risk reward remains extremely favourable with the next catalyst being the second quarter earnings release in late April.
*In addition to owning the stock for clients, I also own the stock personally and for other family members.
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