Good Business vs. Good Investment

 | May 03, 2016 | 1:00 PM EDT
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Stock quotes in this article:

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Last week, Apple (AAPL), the most valuable company in the world, reported second-quarter earnings and revenues that missed analyst expectations. Third-quarter guidance also was below what analysts were expecting. And during the first fiscal quarter of 2016, Apple's revenues came in lower than expected.

After the second quarter's miss, Apple shares fell nearly 8%. It has also been widely documented that, including yesterday's 0.1% dip, Apple shares have declined for eight consecutive days, something that has not occurred in nearly a decade. Over those eight days, some $80 billion has been erased from Apple's value. 

Investors should take great care to learn the invaluable lesson implicit in what has happened to Apple. The lesson is even more critical because Apple is not some new, dazzling tech company with a sky-high valuation multiple. But Apple was, arguably (and still is), the most touted, widely owned and loved stock on the planet. 

So what happens when the most optimistically viewed company that trades for less than 10x trailing earnings reports that it generated $51 billion in revenue and earned a net profit of over $18 billion, a billion dollars less than was expected? The stock tanks. 

Consider this in the context of names like Facebook (FB), Amazon (AMZN) and Netflix (NFLX), which trade between 90x and 540x earnings. It's a not a matter of if but when these businesses will report a "disappointing" quarter or some other news. The optimism and blind faith put in these companies as investments are surely going to cause a lot of pain. (Amazon is part of TheStreet's Growth Seeker portfolio.)

It's important to understand the separation between a good business and a good investment. Amazon is a business of exceptional quality and CEO Jeff Bezos is a once-in-a-lifetime CEO and entrepreneur. I cannot imagine my life without Amazon. But as an investment, I would never go long the stock at these levels. 

A flash to the past: During the 2000 Nasdaq bubble, the most valuable company in the world was Cisco (CSCO), which saw its market cap peak at $600 billion. And Cisco was a legit business with growing revenues and profits and an invaluable business franchise that is still important. Cisco's market cap today, however, is $134 billion. (Apple, Facebook and Cisco are part of TheStreet's Action Alerts PLUS portfolio.)

The starting point matters in investing, and if you make bets when assets are soaked in optimism, don't be surprised if you find yourself swimming naked when the tide goes out. 

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