This mail bag has to do with what appears to be a cheap company such as Apple.
Joshua,
AAPL just had record earnings….the best corporate earnings in human history. Of course, it tanked after earnings like it usually does.
I feel like the whole market has gone mad trading on speculation instead of fundamentals.
What are your thoughts on AAPL? Based on what I see, it’s one of the most attractive buys I can find at the moment.
Mike
In the case of Apple, roughly 50% of the business comes from iPhones. That means if I were looking at adding Apple to the collection of businesses in which I have an ownership stake, the questions on my mind would include:
- How many iPhones did Apple sell last year?
- What was the gross margin per iPhone?
- What is the market share for the iPhone?
- What is the aggregate size of the entire market?
- Is it expanding?
- At what rate?
- How can Apple avoid a fate like Research In Motion? No one saw the Blackberry collapsing and it was almost as powerful prior to the rise of the iPhone. What happens if someone else releases a ground breaking phone that consumers want more?
- Is this the best use of my money right now? Can I find another company offering the same return with a safer revenue stream not subject to disruption?
Can you project, with any reasonable certainty, the units and profitability per unit for Apple’s iPhone business for the foreseeable future?
If you can’t answer those questions off the top of your head, you’re not investing. You’re speculating.
Will any other product rise to add to the income statement, such as Apple television sets, which have long been rumored but still haven’t been officially released?
How does a $400+ billion company get larger? It is a much different company than when it was 1/50th its size. I have a friend who bought Apple shares at a fraction of their current value because the company was much smaller and growing rapidly, even though the valuation multiple was much higher back then. That is not always an irrational strategy and, in this case, it was the right call.
Again, if you can’t answer these questions quickly, and with rationally-based, specific numbers, you aren’t investing.
The question, then, is: What do you think Apple’s cash flow, income statement, and balance sheet look like in 2018 and 2023? A low p/e ratio now is never a justification for buying into a business. It’s future cash flows that matter. You must have some idea what those will look like. If Apple’s earnings fall by half, a p/e of 10 becomes a p/e of 20. If Apple’s earnings double, a p/e of 10 becomes a p/e of 5. You have to look out the windshield and not in the review mirror.
Why would you rather own Apple over Walmart? Or Wells Fargo? Or Exxon Mobil? Or General Electric? You need to be able to respond to that. If your answer is, “the current earnings yield is higher”, that’s always wrong. You aren’t dealing with a boring, stable enterprise like Royal Dutch Shell that pumps crude and natural gas out of the ground, selling it to billions of people around the world. It’s a different calculus.
That’s how I approach allocating capital in situations like this. You have to do what works for you.
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Reader Comments (2)
Comments are presented chronologically, with replies indented beneath the comments to which they respond.
FratMan
March 8, 2013
When you read a story like this, what's the take home lesson (besides the obvious)?
http://tech.fortune.cnn.com/2013/03/04/apple-zaky-bullish-cross/
Joshua Kennon
March 8, 2013
Replying to FratMan
Reading that made me feel sick. The entire thing; and it just kept getting worse and worse.
The first lessons that immediately jump to mind, and that I would scribble in the margins if I had been sitting with a pen over breakfast:
1. You must draw a very clear line in the sand as to which portion of your assets are permanent capital. I do not sell my permanent capital. I do not take significant risks with my permanent capital. I do not buy on margin with my permanent capital. My permanent capital can survive a complete Great Depression meltdown scenario and even if it takes years or decades to recover, should still remain intact. Even one were to lose the house, the car, the job, the furniture ... the permanent capital is not touched. I am not kidding when I say I would sell my car and ride a bike before I'd dip into it. "Never spend principal" is not just some cute pithy statement. It's a commandment that should have been number 11 on the list God gave Moses. For that advertising executive, the $400,000 should have been permanent capital. He could have used it to generate somewhere between $12,000 and $32,000 in cash income per year depending on the asset allocation into which it was placed.
2. I've been meaning to write about this topic, but unless you are writing covered calls, call options are never a conservative investment. They should be banned or illegal for most people. I could write a list of 10 cheap stocks right now but I have no idea what the share price will be tomorrow, let alone 3 months from now. In 1932, stocks were an absolute steal at a few times earnings, but by 1933, they had fallen to even less and in many cases sold for an amount lower than the cash in the bank! If you could have taken over the entire business, you could have paid yourself back with the checking account or by selling off certain holdings! Weird things happen in the capital markets. Always be prepared for them.
3. Never buy or sell an asset because someone else is buying or selling an asset. Every financial decision you make should be something that you understand, based on your own well-reasoned analysis, built on a conservative set of assumptions, and structured in a way that you will not suffer permanent harm if you turn out to be wrong and the worst case scenario materializes. Everyone has a different set of opportunity cost.
4. If you ever find yourself about to do something incredibly stupid with the money, and can't stop it, think about spending it instead. As far as stupid things go, it is the less stupid course of action. It would be much better to drive a new $108,000 Porsche Panorama 4 than lose $108,000 in an investment you didn't understand. Or better yet, buy things that at least have a semblance of value, like sterling silverware, which can not only be used, but can be melted down as an inflation hedge when silver spot prices rise fast in times of depreciating currency. Likewise, I'm not a big fan of parking large amounts of money in non-productive assets, but a guy living in a cabin in Wyoming putting all of his money in gold coins is most likely going to end up with better long-term results (10+ years) than a guy who constantly speculates with derivatives. It's highly unlikely gold will ever go to $0.
5. The United States has to return to some sort of pension system or we are going to vote ourself into a socialist hell given the current democratic leanings of the Republic. People are going to retire, and find they are in a financial mess. Enough folks do it and they will overreact, killing the goose that laid the golden egg, taking the entire American wealth system down with it, which causes even someone on welfare here at home to be in the top few percentage of wealth in the entire world, and the top 1% of all humans throughout all of history.
6. Benjamin Graham was right. Investors should have some sort of minimum threshold below which they don't go, such as holding no less than 25% of assets in well-secured, good-yielding, high-quality, diversified bonds.
7. Most of the time, people make dumb mistakes because they are in a hurry. They want to get richer faster. Rushed decisions are very rarely good ones. That advertising executive is 41 years younger than Warren Buffett. He lost $400,000. He could have enjoyed 41 years, if he's lucky, of dividends, interest, and rents on that money. Had he split the portfolio among, say, 40 securities, each paying quarterly distributions, he would have had 160 days out of 365 days of the years on which he would have gone to the mailbox, or opened his bank statement, to see cash deposited into the account; streams and streams of cash, always coming in, often rising. Forty one years of that ... gone because he was impatient. Don't be in such a rush - driving 130 miles per hour won't get you to your destination any faster because the odds are you'll crash and burn along the way; a portfolio is no different.