MorningWord 8/20/14: $AAPL No-Brainer No More

by Dan August 20, 2014 9:27 am • Commentary

When it’s all said and done, no matter what happens from here, Carl Icahn will reign as the king of this bull run of the last few years.  Make no mistake, the guy has had the Midas Touch.  Consider the following trades:  his buy of Netflix (NFLX) in late 2012, registering gains of more than 300% in a little more than year; calling a bottom in Apple last summer, which might have been a tad out of his wheelhouse; and his recent interest in Family Dollar (FDO), which is up more than 40% in the past 3 months.

Some may wonder after such amazing short term success if his targets and their subsequent rises are not merely sell-fulfilling prophecies.  Just the rumor of his involvement can send a stock up 5 to 10% in a heartbeat (Whole Foods from a couple weeks ago: here).  While the FDO stake demonstrates his continued interest in single stock stories as recently as early July, Mr. Icahn was quoted with a guarded stance towards the opportunity set before him, from Reuters July 10th:

“In my mind, it is time to be cautious about the U.S. stock markets,”

“While we are having a great year, I am being very selective about the companies I purchase.”

Duly noted.  Which makes yesterday’s commentary from Icahn on Twitter regarding his sizable Apple stake all the more interesting:

@Carl_C_Icahn Twitter Feed from 8/19/14
@Carl_C_Icahn Twitter Feed from 8/19/14

Call it what you like, I’d call it a victory lap. I guess from a pure sentiment standpoint this is not exactly the sort of thing that would make me feel better about my Apple holding as it gets back to the previous all time highs. I don’t mean to take anything away from his call, or his transparency on the position, it just smacks a bit of complacent cheerleading, that’s all.

Obviously, the financial media is in a tizzy about Apple trading at par and back at the prior highs, but to me it seems that the sentiment towards the stock is getting fairly similar to August/September 2012 just prior to the company’s launch of the iPhone 5, the last time the stock approached these levels.  Most Apple watchers were in agreement that $100 was in the cards prior to the new phone launch, especially once it got above and held $90.  Remember the followers of Larry Livingston, the protagonist of the infamous trading bible, Reminiscences of a Stock Operator, by Edwin Lefèvre – stock’s that get to $90 get to par, and then up $10, $20 maybe $30.  It’s entirely possible we see that in AAPL, but I am not sure that observation holds for the largest market cap company the world has ever seen.

I suspect AAPL’s price action at these levels will be the stuff that writes trading books for years to come. Is it setting up to be the mother of all double tops with a similar set up into the iPhone 6 launch as to the iPhone 5? Or will AAPL once again pull a rabbit out of the hat and demonstrate the story of innovation that drove the stock’s resurgence over the last decade?  Your guess is as good as mine, but it is important for us non-billionaires to remember, there are NO “no-brainers” in investing.

AAPL 5yr chart from Bloomberg
AAPL 5yr chart from Bloomberg

On the run up to the highs in 2012, many bulls dismissed those who suggested that despite a stock valuation well below a market multiple, the company would not be immune to the law of large numbers.  The stock’s 45% peak to trough decline from Sept 2012 to June 2013 was a clear affirmation of the growth speed bump that was inevitable for a company that had gone from $76 billion in sales in 2010 to $164 billion in 2012.  I think it is also important to note that for those who think that AAPL remains a “no-brainer” from current levels, the company is expected to report earnings for the fiscal 2014 equivalent to that of 2012, despite buying back more than $50 billion of stock since the end of fiscal 2012.  I would also note that gross margins in fiscal 2012 were at their peak at 43.87% vs the expected 38.53% (per Bloomberg consensus) for fiscal 2014, a six year low.

I don’t mean to rain on the Apple parade, but the stock faces the same headwinds that it did back in September 2012. Despite (or at least accounting for) the enthusiasm for fabulous new products, both then and now.  Can Apple again be a double digit eps grower again?  No doubt. All they have to do is continue to listen to Mr. Icahn and lever up and buy back stock with the $130 billion in net cash on their balance sheet.  The stock is amazingly cheap when you ex-out that cash, as it was back in September 2012.

Trust me, I am not calling a top on Apple.  If the company does live up to their increasing unit expectations for iPhone 6, if they re-invent digital music with Beats, if they introduce a suite of services including payments, if they figure out how to grow iPad units in the enterprise, if they finally deliver on more than a hobby in the living room/connected home, if they dominate wearables and create a new category and continue to make inroads into China, then yes, Apple will be the first Trillion dollar market cap company.

But recent history tells us that having multiple consumer hits at the same time will be a tall task.  The likelihood of the stock rising 30- 50% from here, without a meaningful pullback or a long basing period, is not great.