This commentary originally appeared at 8:44 a.m. EST on Nov. 9 on Real Money Pro -- for access to all of legendary hedge fund manager Doug Kass's strategies and commentaries, click here.
Similar to many, I historically (let's call it over the last five years) failed to recognize how successful a Steve Jobs-led Apple (AAPL) would be as a disruptive innovator of product.
In my "15 Surprises for 2012" (written eleven months ago), however, I waxed enthusiastically about the prospects for the profit cycle and share price for Apple. (At that time Apple's shares stood at $403.)
Again, in July 2012, I told a positive tale of Apple's long-term prospects.
Nonetheless, when the shares hit $700 in late September, I turned cautious in "The Bear Case for Apple."
My concerns were multiple and the major risks (most of which I thought would play out over a few years, not a few quarters) were as follows:
- Global economic weakness in 2013 would likely have an adverse impact on Apple's relatively high-priced stable of products.
- Challenges of delivering a high-quality product in quantity.
- The risks associated with the loss of Steve Jobs were being underestimated by the markets.
- Investors may look beyond the recent new product offerings. The steady stream of "wow factor" products in the company's pipeline may be in jeopardy following the release of the iPhone 5 and of iPad mini.
- A changing competitive landscape could be a challenge to the company's market share and profitability.
- Apple's shares were overowned and were the beneficiary of fund flows. The almost religious belief in the company (on the part of individual and institutional investors) represented an extreme in investor sentiment.
- Apple's valuation, though inexpensive relative to the market and its projected growth rate, was very expensive (on a price-to-sales basis) relative to other hardware companies and on an absolute sales basis.
Ten days later, in "More Bruises on Apple," I raised additional concerns. I again asked whether there was anyone left that doesn't own Apple's shares at this point in time and how many money managers (in part because of the weighting in the indices) are now overweight in the stock, particularly after the aforementioned period of outperformance.
Later in October, I underscored why the easy compares and salad days were likely behind this iconic company and that risk/reward seemed uninspiring with the shares being range-bound (and with a lower end of the range at about $550 a share). I concluded that there are now blemishes and bruises on the world's favorite fruit. Specifically, there were early signs of Apple losing its first-mover advantage (and the elevated gross margins previously achieved). I further suggested that investors now must closely watch whether the company's upgrade cycle is lengthening because of a less-differentiated product, they must monitor the ability to deliver a large amount quality product with limited flaws (e.g., apps such as Maps, scratching, Siri, weight/feel, etc.), and they must closely track cost and margin trends and, of course, the competition.
Since I expressed my initial concerns in late September, Apple's shares have fallen by $165.
The shares now stand at $536, and I am buying.
Now let me explain why I have just purchased shares in Apple (my answers correspond to the list of concerns listed at the beginning of this column):
- As I have expressed in my writings over the past few weeks, I am now less concerned about a global economic slowdown than most.
- Investors are no longer smug and have grown increasingly (and arguably fully) aware of the challenges of the delivery of current and future new products.
- Apple's shares are no longer the beneficiary of fund flows -- just the opposite has been occurring, which has materially pressured the shares down to attractive levels.
- At $700, Mr. Market was likely imputing a 2013 new "wow" product (Apple TV?). At current prices, the next "wow" product has been discounted away, and the company's completely refreshed product line (no mean feat in such a short time frame, and if supply comes in line, CEO Tim Cook's main goal for 2013) should be plenty enough new stuff to once again propel earnings throughout 2013. Also, here is a link to AppleInsider, which hints about a possible new product associated with the automotive industry.
- At $536 a share, a discounted dividend model implies that the future growth rate in profits at Apple will be only about 5%. This is too low -- Apple's share price decline has likely now overly discounted most (if not all) of my concerns.