Warren Buffett looks at the company first and then compares it to the price, something most investors (including myself) rarely do. If it’s a great company and its stock price is significantly below intrinsic value, he buys. He doesn’t look at the stock chart, he doesn’t go by technical analysis he just makes his decision regardless of past price movements.
I’ve always preferred looking at stocks trading at new 52 week lows. There is usually huge pessimism on the stock and often the industry is unfavoured. Possibly a great chance to be greedy when others are fearful. However, I recently bought one very popular company with massive analyst coverage and near an all time high.
But first let me ask you a question:
Here is stock XYZ: Earnings per share has increased over 700% in five years, there is no debt, they develop product categories that never existed before and it trades for 12x forward earnings and less than 10x ex-cash. Would you buy? I did.
Of course, this company is Apple and obviously I am more than a little late to catch on to this one but with investing you shouldn’t drive looking in the review mirror.
First here’s how I think my capital can become impaired:
Revenue & Margins Not Sustainable: Revenue is up well over 400% in the past 5 years and net margins are over 20%. This is obviously very high and industry leading. Economic theory dictates that over time competition will erode sales and margins. Apple has avoided this by constantly creating new products and even product categories. When iPod sales dropped, iPhone sales picked up. All the while the company comes out of blue with a the infamous iPad. In my opinion, this is the biggest risk and the reason why its not a huge portfolio position.
Management: Obviously Steve Jobs was an incredible leader at the company. Complacency equals death in the tech world and Apple will need to focus on innovation to maintain profitability. Again, this is another risk that will slowly rise as the old Steve Jobs pipeline runs out.
What I like about Apple:
Closed Loop: Apple has full control of its products from hardware design to software. This is an incredible advantage. Control = Quality (for more see John Hempton’s article on operating system models). There is a reason that Android has had security problems on their phones and why Windows computers frequently crash. Although price was an important factor at the start of the PC era, we are now in the sub $1500 PC and $600 portable device era. Price is not the most important factor, quality is. This is Apple’s strong point. Just ask anybody that uses a mac, it works and works well. This leads me to the next point.
Halo Effect: Obviously this is well documented but its still worth noting. You start with one Apple product, you really like it and all of a sudden your next computer is a macbook air, you’re reading on an iPad and you can’t wait for the iPhone 5. This also creates a major advantage when you launch a new product. Consider two products side by side. One’s made by a company like Sony, Samsung or whoever, the other is Apple. The majority of consumers will go with Apple even if its a little more, they trust that the Apple product won’t disappoint based of prior positive experiences.
Apple Ecosystem: It’s a little creepy but Apple is drawing you into its closed loop ecosystem. All of a sudden you have a bunch of Apple apps, an iTunes account and iCloud files. The more software you use the harder it will be to change operating systems. Of course, these are switching costs and the hallmark of a great business.
Hardware For Software: The more apple controls the hardware the more power they will have have as a gatekeeper of software. This can be seen with Siri which acts as your personal assistant on the iPhone 4s and can perform web searches. Suddenly heading to the Google homepage is not your first stop. And of course the iTunes store has huge value and an ever expanding media library.
How I view the risks:
I try to buy companies that I feel very strongly will be making significantly more money 5 and 10 years from now than today. For example, I am very confident Berkshire will be making far more than today. With Apple, its tech and tech changes rapidly. Although I feel confident that Apple will be making more in 2013 it getsincreasingly foggy thereafter. Lets remember this company nearly went bankrupt in 1997. However, we have to see what’s priced in. At 12x times earnings you are not paying for incredible earnings growth. I view Apple as a call option where you won’t impair the majority of your capital due to earnings over the next 2-3 years (in my opinion) and if things work out well you benefit in tremendous upside.
Disclosure: Long $AAPL
Own a macbook 13inch.
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