$AAPL, AAPL:US, Apple, circle of competence, deferred taxes, disruption, economic moat, growth investing, growth vs. value, innovation, Margin of Safety, Philip Fisher, Steve Jobs, technology, value investing, Warren Buffett
We all know the type: Born-again value investors who still have that new car smell. No longer clueless, but the market hasn’t beaten adequate sense (or humility) into them just yet, so they’re still insanely over-confident. Which we tolerate – after all, we were like them once – then they start expounding their new & improved value investing philosophy, and it all goes downhill. I recall one encounter, some years back, where I struggled to get a word in, let alone offer some kind of reality check. Finally, my new guru was forced to pause & finally breathe, so I did the only sensible thing. I lobbed this hand grenade:
So why not buy Apple..?!
All I got was a puzzled look. Repeating the question, I then pummeled him with a veritable laundry list of Apple (AAPL:US) fundamentals & ratios. If he was such a value expert, surely Apple was a screaming value buy?! Needless to say, I never got much of a reply, but it stopped him in his tracks & scared him off…job well done! But the more I thought about it, the more it seemed like a valid question for other investors (& even me…). And a question to be asked in a spirit of honest inquiry. I mean, let’s look at Apple’s numbers today:
- Net sales have reached $216 billion (as of FY-2016).
- Net sales increased 99% & over 1,000% in last 5 & 10 years, respectively.
- Gross margin increased to 39% ($84 billion) in last 10 yrs.
- Op profit margin more than doubled to 28% ($60 billion) in last 10 yrs.
- Net income increased 76% & almost 2,200% in last 5 & 10 yrs.
- EPS compounded by 16% pa & 38% pa in last 5 & 10 yrs.
- Net cash/investments inc’d almost 1,400% to $151 billion in last 10 yrs.
- Current share price (as of cob Feb-7th): $131.53
- Current market cap: $690 billion
- Current P/S ratio: 3.2 times
- Ex-net cash/investments P/S ratio: 2.4 times
- Current P/E ratio: 15.7 times
- Ex-net cash/investments P/E ratio: 12.1 times
- Current FCF ratio: 13.2 times
- Ex-net cash/investments FCF ratio: 10.1 times
OK, just take a moment & marvel…even with the share price now approaching all-time highs again, surely Apple’s still a screaming value buy?
So why not buy Apple..?!
Ever since, I pose this question to fellow value investors on a regular basis…but I’m not sure I’ve ever received a satisfactory reply!? As in: ‘Yes/No, I bought Apple/I decided not to buy Apple – based on a detailed analysis & the following specific attributes’. Instead, people tend to shrug their shoulders, roll their eyes, flash a rueful grin…and maybe toss out one of the usual objections. I’m sure you can guess a few:
- But Apple’s frickin’ market cap is almost $700 billion now!?
- It’s far too well-researched/efficiently priced for investors to have an edge.
- A much cooler/better/cheaper brand surely comes along for the kids to buy.
- It will inevitably hurtle off a cliff into technological obsolescence/irrelevance.
- The micro-cap sum-of-the-parts thesis we discussed is far more interesting.
- Jobs is dead…the company’s going off the rails any
day monthyear now.
- Look at the bloody chart…who’s gonna buy it now, after that rally?!
Now, before the fan-boys start to lose their minds, this is where I should reveal this post is NOT about Apple. No, really.
Study the long-term chart of any outstanding growth stock & it’s quite obvious most of the objections above are just red herrings. Part of a litany of excuses too many value investors trot out to justify hiding within their own circle of
competence comfort. Because we fear the risks & challenges of the unknown. Instead, we reject (or simply ignore) entire sectors & hundreds/thousands of companies, because we’ve decided they’re just too large, too expensive, too unpredictable, too uninteresting, to be worthy of consideration.
And then we cite Buffett: Always remain within your circle of competence! Except this rule would imply buying no individual stocks…since newbie investors should always choose passive investing initially, as the most prudent choice! And anyway, Buffett evolved his investing approach & continually expanded his circle of competence over his entire career. [Yefei Lu’s new Buffett book offers good perspective]. Mere mortals should emulate such an evolution – not Buffett himself! Unless you plan on being a deca-billionaire too…then you can avoid/invest in anything you damn well please!
Let’s not forget, when Buffett started out, technology was a nascent sector – which required a VC approach – something he clearly wasn’t too comfortable with. [But read Philip Fisher again: Now, he was a great venture capitalist – albeit one who chose to invest in listed companies]. And technology-related hype/promotion during the Go-Go Years probably compounded this aversion, which Buffett rationalised as avoiding the sector’s obvious unpredictability. Except that never stopped him from investing in the likes of banks & retail!? Which are potentially just as lethal & unpredictable…but obviously they were sectors in which he was actually comfortable investing.
But in sticking religiously to his comfort zone, Buffett also displayed his true genius… His apparent caution is deceptive – rest assured, he never doubted his investing ability. Instead, he deliberately chose to leverage his prowess in a new & more aggressive way, via the use of long-term interest-free insurance float & deferred taxes. Of course, the potential risks of taking on such significant leverage ensured he would remain laser-focused on investing (primarily) in predictable sectors/businesses, and obviously inspired his two main rules:
Rule No. 1: Never lose money.
Rule No. 2: Never forget Rule No. 1.
Couple this with super-human patience, and fifty years later it seems almost inevitable Buffett’s accrued an entirely unique investment record.
Whereas we don’t have the luxury of float. And it’s 2017: We live in a world where technology & innovation play an ever increasing role, for decades now, in all aspects of our economy, workplaces & daily lives. And technology isn’t (necessarily) any more unpredictable than biotech/pharma, fashion, media, retail, natural resources, emerging/frontier markets, etc. But it deserves far more focus & study…since its potential impact on other sectors, in terms of innovation & disruption, is obviously far greater today (& as we look ahead). [With autonomous trucks now being tested on open highways, it’s both astonishing & alarming to realise truck driving may still be the most common male occupation in the US (almost 3 million drivers)!].
A value investor who deliberately avoids technology/other such (unpredictable) sectors is foregoing a world of investment opportunity – especially now, when an ever increasing share of economic value-creation is derived from technology, not to mention other intangible assets/intellectual property. And trapped in a low-growth low-return world (like today…or in due course, as debt & entitlements keep escalating), such investors may end up condemned to choosing between: i) traditional blue chip/Buffett classics (e.g. food/beverage stocks) which now seem to trade at ever-expanding multiples (vs. historic & prospective earnings growth), or ii) traditional value stocks which can perhaps no longer rely on a rising tide of growth, inflation & animal spirits. Who can afford such risks & opportunity cost?
But for many value investors, we’re far more comfortable with the numbers, rather than the story itself…which is, potentially, our downfall. [And vice versa for growth investors]. The hard assets & cheap metrics of your typical value stock offer the siren song of safety, whereas investing in high quality/growth stocks may require a far more demanding leap of faith. Except value stocks are often mired in bad management, bad business models, bad industries & dreadful capital allocation – with little hope of compounding their intrinsic value – the best we can hope for is a realisation of intrinsic value.
If you’re a human computer who loves to re-rank & re-invest in the world’s cheapest stocks every day, such an event-driven portfolio may be rewarding (& the studies do claim value beats growth), but in the real world how many investors manage to deliver sustained long-term out-performance with such an approach? Maybe a passive computer-driven portfolio is the better solution, especially when the greatest human computer of them all (i.e. Buffett) has long abandoned such an approach. In the end, value investing will always be a marvelous valuation tool & framework for investing, but its greatest failing doesn’t lie in the stocks it green-lights for you to buy…
It actually lies in the stocks it persuades you NOT to buy!
I suspect most value investors will freely acknowledge this failing. And embrace the proposition that investing in high quality/growth stocks is ultimately a far more attractive way of compounding long-term portfolio value (particularly on a tax-deferred basis), IF ONLY it weren’t so bloody difficult! Because such an investing approach must inevitably be driven by qualitative, not quantitative, analysis. And it conflicts with having our cake & eating it – we want the best companies and the best prices! In reality, we need to compromise & choose wonderful companies at fair prices, not fair companies at wonderful prices. Which actually offers a far more compelling value equation, since time is the friend of the wonderful company, the enemy of the mediocre.
And so, paying up is often required – well, at least from a traditional value perspective – which, almost inevitably needs to be justified via comprehensive study of the company & its management, its capital allocation, its products & business model, its industry dynamics, and (most of all) whether it enjoys a significant, sustainable & (ideally) an expanding competitive advantage (i.e. an economic moat). An exercise which is surely infinitely more challenging than assessing & ranking a bunch of value metrics. And one which can go horribly wrong – a busted value thesis may engender some rueful sympathy (wow, who knew management were such idiots..!?), but paying up for a high flier just before it collapses will inevitably attract a perfect storm of hindsight & sniggers for making such a bone-headed investment decision. But then again, nailing even a single multi-bagger growth stock might yield a payoff value investors can only ever dream of…
Of course, today the answer might not be Apple…but next up there’s a world of other compelling investment opportunities out there just waiting to be explored. Which means it’s still an excellent question to kick off your search:
So why not buy Apple..?!