Four reasons why we continue to invest in Apple5th January 2016
Apple is the largest position in our equity funds at just over 12% of the fund as at 31 December 2015. During 2015 the stock price declined by 4.6%. Given its size in our equity portfolios and its stock performance during 2015, it was gratifying that the position delivered a small profit for the year.
Apple is an extremely polarising stock in that investors either love or hate it. This has resulted in a substantial amount of volatility in the stock price for such a large business. Investors who are negative on Apple seem to focus on four key issues which are set out below along with our opposing view.
1. A declining growth rate in iPhone sales with no replacement product to sustain the growth rate
This is simply the law of large numbers. Growth rates inevitably decline. At around $100 per share, Apple is trading at just over 8 times current year earnings after adjusting for its substantial surplus cash. In comparison global equity markets are trading at around 15x earnings. If Apple was trading as a growth stock at over 20x earnings we would see this as a real risk. However current pricing is assuming a significant decline in earnings which we do not believe is likely. In addition we believe that Apple has a number of existing products and potential new products that will improve its ecosystem thus enhancing its competitive position.
2. Single product risk with iPhone sales accounting for two thirds of sales
This is a real concern with 66% of sales coming from the iPhone and a clear historic precedent of what happened to Nokia and Blackberry. However, we believe that the Apple ecosystem provides Apple with a competitive “moat” that Nokia and Blackberry did not have.
3. Increasing competition from lower priced Asian competitors impacting margins
Again this is a real risk. Our research indicates that even today with existing cheaper smartphone options Apple continues to win market share in China without pricing pressure on its premium priced product. Even if there is margin pressure, at current valuations earnings could decline by 30% and Apple would still trade at 11.5x earnings.
4. With over 20% of sales now in China, a slowing Chinese market will negatively impact sales
We have been bearish on China for over 4 years now and are more in the hard landing than the soft landing camp. We however believe that consumer orientated businesses are better positioned to weather any downturn than manufacturing businesses. Furthermore this impacts all multinational companies and therefore should not drive the significant valuation differential to the market as a whole.
In summary we concur with all of these concerns but believe that the current market valuation more than discounts these risks. Even if all of these risks materialise, which we believe unlikely, the risk of a permanent decline in the valuation is low whilst the potential for substantial profit is high.