Portfolio Review: Apple

Being the largest company in the world by market capitalization, there is a lot written about Apple. Obviously the Company is widely followed, and you would expect the market for its shares to be as close to efficient as a market can be, so what chance of outperformance is there? I am consistently surprised by how volatile the shares of such a large company can be: Over the last 18 months or so, the shares have traded for as high as $100 and as low as $64, while arguably nothing major has changed with respect to the long term value of the business.

Company: Apple Inc.

Investment Thesis: Apple is (1) a solid company with great stable of products. (2) it trades at a reasonable valuation and (3) there is great optionality in the future of the business.

(1) Solid Company with Great Stable of Products: I won’t dwell too much on this point. By some metrics, Apple is the largest company in the world. It’s main products are iPhone (53% of 2013 sales), iPad (19% of sales), Mac Computers (12% of sales) and iPod (5% of sales). It is a market leader and category definer across the board, sporting very high gross margins (37.6% in 2013) to prove it. It distributes through a variety of channels, including its own retail stores (13% of sales in 2013).

(2) Valuation: Apple trades at 15.7x trailing earnings. That is right around the long term average for the stock market and a fair value for business of the scale and clout Apple offers. The business is highly cash generative and has been actively returning capital to shareholders. Apple started paying a dividend  in 2012 and has grown it significantly since (current yield of almost 2%).  The Company has also been deploying significant capital towards share repurchases ($33.9bn over the last 12 months), especially while its share price has been somewhat depressed.

(3) Optionality in the future: Apple is not a bargain, it is fairly priced.  What makes the investment attractive is that we can earn a fair market return and get an option on the Company’s future developments. I feel confident Apple can continue to innovate enough to maintain its current level of earnings over a long time, and that alone would represent a good return on my investment. I really like the idea of buying a business at a fair price that will earn a decent return under regular circumstances, but have some upside in the event that a new product introduction is successful.

I think the chart below is instructive to see the effects of a successful product introduction:

Apple Revenue Growth since the introduction of the iPod (Source: CapitalIQ and Company data)
Apple Revenue Growth since the introduction of the iPod (Source: CapitalIQ and Company data)

The “next one” may or may not come. If it doesn’t then I expect my investment in Apple to have a mediocre but acceptable return.

Conclusion: Apple offers a good return for the level of risk in the long term. The Company has great products and generates a lot of cash. One new successful product launch in the next 10 years would be enough to make this a great investment. Even if that does not happen, I expect the company would generate an acceptable return.