It was hard to miss. After 100 years in the Dow Jones Industrial Average, AT&T (T) is out, and Apple (AAPL) is going in on March 18th. There’s no shortage of symbolism here as AT&T was AAPL’s exclusive distribution partner for the first five years of the existence of the iPhone, which was riddled with problems, and in hindsight might have been a massive bonehead move by AAPL giving lower priced Android phones plenty of room to run with more than half of America’s mobile consumers.
Aside from that, the addition to the Dow is inconsequential from a share demand standpoint as very few funds index the 30 stocks. And one could argue that from an investor sentiment standpoint the inclusion could be a negative as these are always buy high sell low situation as well as being lumped in with 29 other stodgy stocks. Not to mention that the other tech stocks in the index CSCO, IBM, INTC & MSFT are not exactly viewed as pillars of growth and innovation. But let’s move on, I don’t trade the Dow, I certainly don’t quote it, and on most days gun to my head I could not tell you where it is within 500 points.
The Main Event for Now: The Watch Obviously
On Monday Tim Cook will take the stage at afamiliar gathering of very friendly media peeps to introduce their first new product category in five years. Since the device’s announcement in the fall the excitement about the device has ebbed and flowed with dare I say, fairly low expectations going in with concerns about the battery life and usefulness out of the gate affecting demand. Analysts seem to downplay its near term financial impact while those in the financial and tech press seem to be less than sanguine about the devices uptake in its first year. And that’s probably a good thing for AAPL investors as any positive surprises on reviews, sales and functionality may actually be positive for the stock.
Regular readers know that it’s my view that this initial foray into a segment will be disappointing for now. I hold this view only temporarily as I do think wearables will ultimately be a cornerstone of mobile computing and Apple’s track record tells me they’ll get it right, eventually.
But while AAPL products like iPhone and iPad have dominated the consumer electronics landscape since their respective intros in 2007 and 2010, it’s important to note that AAPL has gotten a few things wrong on design in their first iterations. While initially dictating consumer trends on such things as size, they have been forced to adjust to the global market. The original iPhone’s screen size was 3.5 inches, a size that Steve Jobs was fairly adamant was the right size. After more than a few iterations, the screen size was increased to 4 inches in 2012, and ultimately 4.7 inches and 5.5 with last September’s release of the iPhone 6. At this rate they’ll be the size of a boogie board in 2022. This was all after Android competitors had been dominating the larger screen market for years.
And the iPad was originally 9.7 inches and Steve Jobs famously stated that their competitors’ 7 inch tablets were going to be DOA. A year after his death AAPL introduced the Mini at 7.9 inches and rumors suggest that they are in the works to produce a 12 inch device for the fall that of all things may make use of a tool that by all accounts Steve Jobs hated, the dreaded Stylus.
You get the point, they have been known to get things slightly wrong initially and adjust later, and I suspect the Watch will be no different. Its too big for most woman’s wrists, most models will be too expensive for mass market, battery life will be weak, it wont work as a standalone computer etc, etc. I am sure they will get most of these things right in the years to come, and I would guess that wearable computers on your wrist will have a very nice future. Just not immediately, and it will not move the needle for a company expected to book $225 billion in sales in the current fiscal year.
So heading into Monday’s launch event, curb your enthusiasm for the Watch. But don’t let that erode your faith in the company itself. The increasing calls for $1 trillion in market cap are getting louder, and that’s likely to be a layup! (sarcasm font needed). Increased capital return is obviously another potential catalyst, but at this point it is expected. And after such a massive ramp in eps growth expected this year from 14% in fiscal 2014 to 33% this year, and consensus deceleration to only 8% in fiscal 2016, the company will need to maintain their level of buybacks to maintain the stock’s multiple.
I would add that with more than two thirds of the company’s $178 billion in cash is overseas, and 60% of their sales are overseas and a lot of expected growth, so the strong dollar could start to take its toll and keep them tapping the debt markets before rates go up too far too fast. So the story in my mind is no longer a no brainer. I know, I know. This has not exactly been on my shopping list for a while, and to be frank I find it more interesting to attempt to poke holes in the universally loved story. But don’t worry. I suppose that I own plenty of AAPL shares through mutual funds and retirement accounts, so I am not totally out of the game. While I am not going to go into anymore detail as you are likely bored, I also think AAPL could have an impending Rich People Problem in the next economic downturn, read here from this morning.
So there you have it, my somewhat ambivalent view on AAPL for the moment.
For those who are long and think the stock currently incorporates a bit of good news:
You might consider overwriting your stock in an effort to add a little yield, but vol is still pretty low and generally call sales don’t look attractive as they provide little buffer to the downside and need to go to close to the money to add meaningful yield.
But for those who do not want to sell but worry that sentiment is overheating you could consider a collar, looking out to may that will capture Watch release, likely a report on initial sales, capital return details and their fiscal Q2 results expected in late April.
Hypothetical Overlay vs 100 Shares of AAPL stock long $127.50
Buy May 140 / 115 Collar for Even Money
-Sell to Open 1 May 140 call at 2.40
-Buy to Open 1 May 115 put for 2.40
Break-Even on May Expiration:
Profits: Gains of the stock between 127.50 and 140, up to 12.50, stock called away above 140, up 10%
Losses: of stock between 127.50 and 115, or about 10%, protection below $115
Rationale: With the stock up 15% on the year, gaining more market cap in 2015 than 460 stock’s individual market caps in the S&P 500, I think one could say there is a good bit of enthusiasm wrapped up in the name with very well known catalysts. One would collar stock if they do not want to sell, but would be willing to give up some upside for potential disaster protection. Those potential scenarios would look like this:
1. Watch fails to impress and initial sales disappoint.
2. Management does not go far enough in April for increased cash return
3. Fiscal Q2 results is marred by strength of dollar, iPhone sales not as hot as expected and investors start to realize few catalyst between then and Sept iPhone 6s launch