By Brian Nichols
A “Value of the Month” would be a stock that is presenting such clear value that it can not be argued. It’s a company that has lost value for reasons other than fundamental performance, such as fear or speculation. For February, I think it’s clear to see that the very best value in the market is also the market’s most controversial stock — Apple Inc.(NASDAQ:AAPL).
A Look Back at “Values”
First, for some quick background information: I have written 100’s of articles and every year I pick both a “Value of the Year” and have published three ‘Value of the Month” articles. For 2012 my clear value of the year was Sprint Nextel (NYSE:S). It was a stock that had fallen due to market perception but had also just received the rights to sell the iPhone, a device that strangely enough contributed to its fundamental downfall. My theory was that if Sprint was worth $5 in 2011 without the iPhone then it was worth a lot more than $2.30 in 2012 with the iPhone.
As most people know, Sprint returned gains of almost 150% in 2012; however I sold Sprint back in December due to increased competition and new carriers that were selling the iPhone 5. And as a result, I made Alcatel Lucent (NYSE:ALU) my new “Value of the Year”. Since December 13, when I wrote the article and made the change, the stock is higher by 60%. I chose the stock as the best value of the year because of the restructure that is occurring before our eyes. It was a company valued at just $2.50 billion with revenue of almost $19 billion. Now, with the company selling and restructuring much of its business, the company’s cash position shall improve as will its margins. If you look at other companies in the space such as Cisco Systems, Inc. (NASDAQ:CSCO) and Juniper, it’s clear that margins are what concerned investors in this space. Therefore, it may sell half its business, but if it can trade at two times sales then we’re looking at a company valued at $18 billion with upside in the American and Chinese markets.
Aside from Value of the Year plays, the current performance of the only three previous “Value of the Month” plays is as followed:
Each of the three picks above has greatly outperformed the market since coverage. First Solar Inc. (NASDAQ:FSLR) showed great progress following its earnings in August; XPO Logistics Inc. (NYSE:XPO) is currently trading at about 0.50 times 2013’s sales and has more cash on its balance sheet than its market capitalization; and Seagate Technology (NASDAQ:STX) also trades with an incredibly low P/E multiple and had been pushed lower due to fears of a declining PC business model. Each stock has had periods of volatility, but over a period of many months, the value was clear as a good choice, and shall continue to produce gains.
Why is Apple a Market Leading Value?
Apple Inc.(NASDAQ:AAPL) has lost about 37% of its value since the end of September and is trading with a forward P/E ratio of about 7.0 (minus cash). It’s still expected to grow between 20% (worst case) and 30% (best case) in 2013 and most of its loss is a result of fear that its growth is slowing, margins are falling, innovation is stopping, and that we could see a passing of the torch in the technology space to Samsung (KRX:005930) or Google Inc. (NASDAQ:GOOG).
To effectively explain Apple’s value I’d like to refer you to an article written by Michael Shulman. While writers have broken down Apple’s fundamentals from component suppliers to the route taken to deliver iPhones in China, Shulman offered a very sensible approach to Apple’s most recent earnings, the one that caused a $70 decline. He showed how the market got it wrong when it came to post-earning reactions between both Apple and Google. For example, Apple had profit growth of 13.5%, trades for less than 12x earnings and sold-off 4% (at the time of his article). Meanwhile, Google grew 5%, trades at 31x trailing earnings, and increased in value by 5%. With Microsoft (NASDAQ:MSFT) it’s even worse: Apple and Microsoft have a near identical forward P/E ratio minus cash yet Microsoft’s growth ranges from (5%)-3%. I think it’s obvious who the clear winner is in this comparison. So how can this “logically” be explained?
The answer to the question is that it can not be explained, and that Apple’s reaction is solely a result of perception. When you look at its growth compared to worth it’s impossible to explain its value, and then when you compare it to other industry players such as Google and Microsoft, the value becomes even more apparent.
Some are worried about a lack of innovation and believe that Apple products are becoming “less cool” therefore you need to refer to the company’s ecosystem. Sure, I would love for Apple to announce a new Apple TV, a newly designed phone, or maybe a computer that reads your thoughts, but the truth is that there is no rush for a company with 20% growth and $165 billion in revenue. Apple continues to operate like Apple, they give you no hints and they build anticipation. Google, on the other hand, tells us about cars that drive themselves and sun glasses that put you in a virtual world, yet continues to return most of its revenue from advertising and fails to monetize these spaces. The companies simply have a variation of style when it comes to product launches; therefore I see no reason to believe that the company is not innovating.
A couple years ago I suggested that Apple could lose its spot as the top mobile phone developer to a competitor. Over the last two decades we’ve seen this shift in power, from the Motorolla Razr to the Blackberry, as new companies innovate and surpass the dominate companies of the past. However, Apple is more than just a mobile phone company; it has an ecosystem with iTunes and the App Store that can not be replaced without a coordinated effort by the millions of consumers and businesses who utilize this ecosystem. Therefore, with value, growth, and an industry best ecosystem, I believe that Apple is without question the best value for the month of February, and is probably worth twice its current valuation.
How to Play Apple (AAPL)
Aside from having value, growth, and a great ecosystem, Apple has also become a great dividend stock. It’s currently trading with a yield of 2.35% and when combined with its valuation I feel quite comfortable in saying that an investor could buy, hold, and return gains over the next 16 months. However, there is perhaps one more factor to consider and that is human behavior when dealing with a stock that is trading as volatile as Apple.
In my book, “Taking Charge With Value Investing” which is now available on Amazon or at your local book store, I talk in detail about how investors react to the prospects and the reality of both gaining and then losing money. When we are gaining money we are more likely to continue to partake in an activity, whether it be at a casino or in the market. But when we lose money we become more restless and more likely to make emotional based decisions.
These decisions, which will ultimately hurt your return, can be avoided in two ways: Use limit orders and buy in spurts. When a stock is trading as volatile as Apple it’s very hard to buy, hold, and then not react to the price performance. You have to remove yourself emotionally from the stock, set limit orders for various times to purchase various numbers of shares. Don’t place all your eggs in one basket. If you want to acquire 50 shares, then why buy all today when we don’t know the immediate trend. Why not buy 5 or 10 shares each week or each month to ensure that you are buying at the best price and that you can mentally withstand selling pressure? Think about it, if you buy 50 shares today and it falls to $410 in three weeks then you will be devastated to see those losses while other stocks rise. But, if you spread the investment over a course of 3-6 months then you will be able to buy at those cheaper levels, or if it rises then you’ll know that some gains are already locked into your portfolio. Of course there is a deep psychological meaning to this one strategy, which is explained in my book, but for discussion purposes there is not enough time to thoroughly explain. Just try it one day!
I have written 100’s of articles and I am wrong quite often. If I write an article looking at five stocks with upside on any given day then chances are I am going to be wrong on at least two; that’s just the name of the game. However, to pick a true value stock the value must be apparent, and you must fully understand market behavior/psychology. Apple has fallen more so because of perception, and chances are that if the company would’ve been more prepared for the iPhone 5 launch, and wouldn’t have had a three week backorder, it would be trading at $800 rather than $450. However, the stock’s price of $450 gives you a clear opportunity to buy a stock that might not perform right now, but will perform over a course of several years, will outperform the market, and has limited downside.
Brian Nichols is a blogger, author, and investor. Brian studied in the field of psychology and has researched extensively into behavioral finance, which include fear, emotional reaction, and all other emotions and or decisions that are clouded from an investor’s thought process as a result of money making (or losing) decisions. Brian uses his knowledge of psychology as a way to find value in the market and capitalize on the fear and irrational thinking that creates value in fundamentally strong companies. Brian is neither a long or short-term investor but invests with a system that includes selling once certain price targets are reached. The strategy can take weeks, months, and sometimes years but if the company is truly undervalued it will almost always return sizable gains. Brian explains this process in detail in his upcoming book “Taking Charge With Value Investing: How to Choose the Best Investments According to Price, Performance, & Valuation to Build a Winning Portfolio” which will be released in February 2013 by McGraw-Hill.