Apple's Biggest Problem: Mr. Market

 | Jan 24, 2013 | 2:00 PM EST
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It should come as no surprise that Apple (AAPL) dropped nearly 10% after it reported its quarterly results yesterday. Over the past couple of weeks, the market all but ensured that Apple's shares would drop significantly once the earnings were released. By that I mean that Apple's biggest problem today is Mr. Market and not its financial performance.

In the current economy, Apple's quarterly results were nothing short of spectacular. For the fiscal fourth quarter, Apple again posted record quarterly revenue of $54.5 billion and record quarterly net income of $13.1 billion, or $13.81 per diluted share. But Mr. Market had made up his mind weeks before Apple's earnings release. Unless Apple again blew past estimates, the stock was going down no matter what.

Apple bulls need to pay attention. Apple remains a paragon of innovation. But right now, the issues are expectations and market psychology. You have a stock that is now trading for about $470 a share that appears to now be trading for about 10x earnings and yielding 2%. Mr. Market doesn't care about any of that in the short run. What he focuses on now is that Apple's future earnings, as fantastic as they may be, may no longer deliver the growth they once did. That uncertainty alone is enough to continue pressuring the stock.

Furthermore, Apple has become the ultimate cult stock. A few months ago, I read an article about families who had their entire retirement invested in one stock, Apple. On top of that, many investment firms that typically don't allocate more than 5% to a single position have Apple representing 20% to 30% of their overall assets.

What do you think happens, regardless of whether it's rational or not, when a stock like Apple eventually succumbs to the inevitable? Apple shares were not going to go up forever. When shares drop from $700 to $600, loyal investors don't flinch, because they've seen it happen before -- a healthy pullback before going to $800. Then the stock drops from $600 to $500, and believers start getting a little nervous, perhaps selling a little to lock in gains and holding on to the rest.

Now the shares are around $450, and many are starting to get nervous, not wanting to see whatever gains they've earned disappear, so further selling takes place. Remember also that Apple's rise from $500 to $700 meant that a lot of people were buying at those prices. Many institutional funds have automatic mandates to sell a stock upon a 10% to 15% loss trigger.

Of course, the biggest irony of all is that a lot of people who loved that they had bought Apple at $600 when it was trading for $700 will be quick sellers today at $450. When a stock is declining, investor psychology goes haywire and leads many people to make the wrong decision. After all, that's why bubbles exist.

If Apple's profits were to stop growing today but remain at current levels of over $1 billion a week, and if the company were to use those profits to buy back stock and pay dividends, the shares would not be that expensive today. Of course, that is not going to happen anytime soon. But as I said in a prior column, Apple no longer has the market all to itself, and if that company launches a lower-priced iPhone, as it is rumored to be doing, that would reduce margins. But if those margin reductions lead to an increased market, that's a very good thing.

In the meantime, faith among many Apple believers is going to be tested by Mr. Market, and one should expect above-average volatility going forward. 

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