Market Playground

By James Roberts

Apparently I had lots of company when I purchased an iPhone 5 in mid-October. In the October 15, 2012 edition of “Dow Theory Forecasts” there was a comment about iPhone 5 sales.

The gist of the article: iPhone 5 has received some good press, Apple Inc. (NASDAQ:AAPL) will probably increase its market share from the company’s current 17% slice of the U.S. mobile-phone market this year.

The article uses an unnamed source for an estimate that 70% of those buying the iPhone 5 this year have never owned an iPhone. That is true for me. I am apparently not an early adopter.

I did, however, subscribe to Netflix (NASDAQ:NFLX) in 2001 and retain my membership until the end of July this year. The iPhone was mentioned in the second Presidential debate (see transcript) by the moderator as an example of a hot selling product that is made entirely in China.

I suppose that any mention in such a widely viewed program is a plus. I heard another commentator suggest that iPhone sales may have goosed the retail sales numbers in the U.S., released this week.

Judging by the decline in Apple last week, I had lots of company when I sold the Apple holdings of my Covestor models. It is not a good thing to be a part of the herd in the arena of long term investing, at least, according to Warren Buffett and David Dreman, to name just two value investors.

Dow Theory Forecasts (DTF) justified its contention that Apple continues to be worth holding based on a reasonable PE multiple and continued favorable growth prospects.

In fairness, I believe that DTF bases its investment advice on a quantitative model they call “Quadrix”, which includes some earning persistence numbers as well some aspects of “growth at a reasonable price.” People who admire Apple as a company and its products make up a huge contingent. I am among them.

Why then, did I sell the stock? In the late stages of the tech bubble in 1999 or 2000, some shrewd observers noted that Microsoft Corporation (NASDAQ:MSFT) could not continue growing at the rate that it was enjoying at the time because the law of compounding would propel Microsoft’s sales to a level approaching the U.S. gross domestic product (GDP) at some given future date, maybe 10 or 15 years.

At that time Microsoft was selling at what we, in hindsight, know to be an exorbitant multiple of earnings. We also know that earnings growth slowed  and the PE contracted for Microsoft and other high fliers riding the tech bubble.

While I agree with DTF that the PE multiple of Apple is not unreasonable, I am concerned that it regularly vies with Exxon (NYSE:XOM) for the title of having the largest total market value of any stock in the world. Microsoft has been among the contenders for that honor in years past.

I know that at least one hedge fund manager was short Apple during the last market correction. I do not know the reasoning behind his short, nor do I know if he still maintains his bearish bet the stock. I know that he is in the value camp and prone to be a contrarian.

I’ve heard him tell of the misery of being short too early in the tech arena before the bubble burst. I am mentally preparing myself for being somewhat uncomfortable in having sold my Apple holdings. The last time I checked, Warren Buffett did not own Apple.

His aversion to tech stocks continues, despite his purchase of International Business Machines Corp. (NYSE:IBM). His reason is that technical innovation eventually makes everyone’s technology products obsolete. That reasoning largely removes tech stocks from the small number of companies that can boast of having an economic moat of protection from the encroachment of competition.

I don’t know whether the following saying comes from my days as a real estate appraiser or from my extensive study of the stock market investing process.  Here it is: “Excessive Profits breed ruinous competition.”

Another phrase that I encounter quite often in my investment reading is “reversion to the mean.” That is statistical jargon meaning that when things get too high and too popular they tend to eventually come back to normal.

It works the same way with stocks that are unpopular. I remember the time when the Franklin Templeton family of funds had holdings in Philip Morris (NYSE:PM) in a number of their different stock funds.

That was shortly after the successful class action suits against the tobacco companies. The positive stance was a minority view, despite the rich dividend prevailing in tobacco stocks at the time.  The overweight position in Philip Morris was the right call, once again validating the great results available to savvy value investors.

All of my models have considerable exposure to the value style of investing through ownership in Berkshire Hathaway, class B (NYSE:BRK.B). The methods that I use are predominantly quantitative, with a nod toward fundamental measures, seeking growth at a reasonable price.

The above article comes from Covestor. For more information on James Roberts, and to view his Fortune’s Most Admired, StockDiagnostics and Best Ideas Covestor Models, visit Covestor.com. 

Covestor Ltd. is a registered investment advisor. Covestor licenses investment strategies from its Model Managers to establish investment models. The commentary here is provided as general and impersonal information and should not be construed as recommendations or advice. Information from Model Managers and third-party sources deemed to be reliable but not guaranteed. Past performance is no guarantee of future results. Transaction histories for Covestor models available upon request. Additional important disclosures available at http://site.covestor.com/help/disclosures. For information about Covestor and its services, go to http://covestor.com or contact Covestor Client Services at (866) 825-3005, x703.