After we sold Babble to Disney in late 2011, we put an “irrationally” large portion of the proceeds into Apple stock. Every sensible person I spoke with about this told me it was a crackpot move, and I should be beaten about the head and the neck with a French baguette.
Apple has been a roller coaster ride in the last several years, and there have certainly been times when I have questioned the wisdom of our decision (overall it’s been a good run up in the last three years, though shy of the performance of the Nasdaq 100 during the same period). Instead of reducing our position, which most level-headed fathers-of-three would have done, I have doubled down in recent weeks, increasing our AAPL stake to about two thirds of our total portfolio. Nuts, right? We do not intent to keep it this high … the plan is to sell perhaps half the position going into Apple Watch hysteria in the Spring.
As you can imagine, I am feeling some suspense as we wait for Apple to release FYQ1 Earnings in a few hours. I will either be bent over and spanked by the whimsy of the market – and reminded that we really should be index funds – or rewarded for my derring-do (which may or may not be a good thing).
For those interested, here is my longstanding investment thesis for our Apple position, followed by my case for making large, asymmetrical investments (diversification is for wusses is the short version), which clearly, given the drubbing I regularly receive from my savvy friends, runs counter to conventional wisdom.
Here’s why I think Apple is a good medium-to-long term play:
People just like Apple better. This has been true for a long time – every customer satisfaction survey, and purchase intent survey – I have seen dozens of these in my compulsive reading in the last three years — always shows that the preference for Apple products exceeds Apple’s current market share. The data also consistently show that people using iOS devices spend more time online, and spend more money, by a wide margin. Sure, there are a subset of early adopters and tinkerers who speak loudly about the advantages of Google’s more open platform, but survey data has shown again and again, for many years now, that iOS makes people happier than Android.
I think the explanation is pretty simple – the more complex the world gets, the more people value simplicity, and no one does simplicity better than Apple. The irony is that the same priorities that caused Apple to lose to Microsoft and friends in the 1990s – obsessing on design simplicity, ease-of-use and the beauty of the product at the expense of cost savings and choice – are the priorities that have enabled Apple to move into a dominant position in the age of mobile computing. Needless to say, form is more important when your computing device is a fashion accessory, and simplicity and ease-of-use are more important when the average user has more than 80 apps on their phone. Bandwidth constraints and the comparatively small size of phone screens also rewards the more simple, consistent and reliable user interface.
So why, I have asked myself for years, has Apple’s market share not kept up with customer satisfaction and purchase intent data? The best explanation that I have been able to come up with is that Apple’s market share has been unnaturally constrained by more limited carrier options (particularly overseas) and form factor options (most notably the absence of large screen size options) and higher price points. So my core investment thesis – not terribly sophisticated or original stuff – was that as carriage increased, and more screen size options and price points were offered, that Apple would assume a dominant position.
Well, it’s taken an awfully long time – Apple moved much more quickly with the iPod to make it available in every form factor and price point than they have with the iPhone, and in retrospect this was clearly a mistake. But finally Apple has (for the most part) delivered, and we are seeing huge market share increases.
An equally important question is why Apple trades at a discount to the market — an unbelievably cheap multiple of 10x forward earnings when you back out cash — when it is wildly outperforming most companies. I think there are three mistaken assumptions, common among investors, that artificially depress Apple’s value: the first is that we would inevitably see a repeat of the Apple vs. Microsoft battle of days yore (mistaken for reasons described above); the second is that Apple’s innovation was all because of one man, Steve Jobs (recent products and performance prove this to be wrong — Steve was critical, but he was also a major impediment); and third is that the most valuable company in the world cannot continue to grow at this clip (mistaken because the vast majority of people on the planet still do not have iPhones, not to mention Apple Watches, TVs, Macs, and whatever is coming next). My friend Jay Haynes provides a great analysis of Apples more rational value here — http://bit.ly/1b85AUu.
The market is easily disappointed, and expectations tonight are extremely high. I am optimistic … signs indicate this is likely to be a big one … but it’s always possible that manufacturing constraints will result in a merely great quarter, rather than a truly extraordinary quarter, and this could result in pain for outsized Apple investors. It’s happened before.
If the stock gets a lift, we will unload some and begin to diversify. If AAPL pulls back, we will wait it out, because I think 2015 will be an extraordinary run for Apple. I think the Apple Watch will over-deliver (despite legitimate battery concern), Apple Pay has the potential to be a juggernaut, and I think the home and health app ecosystems will be transformative in the next few years.
In terms of stock movement, though, looking beyond 2015, I am less certain. There is no question in my mind that Apple will continue to grow at a staggering rate – staggering for the largest company in the world – but I have learned in the last few years that the market is emotional, and revenue and market share are not enough if investors lose faith, which is what happened in late 2012 and 2013.
I also believe that there are cycles of single platform dominance (think: AOL in the 1990s) and diversification (think: explosion of the internet thereafter). It seems logical to me that single platforms dominate in periods with bandwidth constraints (early internet, and early mobile) when a controlled environment can deliver a better experience. At some point, extraordinary innovations and more consistent design standards outside the controlled platform start to lure people away … it’s cyclical. I wouldn’t be surprised to see the mobile web start to pull people away from the app ecosystem in 2016 and beyond. I also think that Oculus Rift and Microsoft HoloLens are awfully compelling and gesture towards some big changes in the next decade.
The AOL comparison above is actually quite apt — my first investment was $1,000 (every dime I had) in AOL in 1991 or 1992. It grew 100x, if you can believe it, in the next 8 or 9 years, and then lost 80% of its value following the Time Warner merger. I will never forget reading an article in Wired magazine in mid-90s, when I had made 10x in AOL and was considering selling, in which Steve Case was quoted as saying “The average internet user is getting less sophisticated, not more sophisticated as more people come online” and thinking, “he’s right, I won’t sell.” The globalization of mobile devices is not dissimilar. Having said that, I learned a lesson by holding AOL too long. Cycles.
The case for asymmetry: I do believe that making large bets in the market you best understand, is among the better ways to generate outsized returns if you are risk tolerant. Think of it as extreme Warren Buffet principle — instead of investing “in what you know” across 6-12 companies, invest overwhelmingly in the one company you know best and believe in most. You will also end up learning in the process, like it or not … I have read several posts every day for twenty years now about companies in our portfolio — compulsively, involuntarily — and this has probably helped with my broader understanding of the marketplace. (Our biggest bets, for those interested, are, in order of size: Apple, Google, LinkedIn, Chipotle Mexican Grill, and Tesla, all of which I believe in as long term holds.)
Having said all that, as I sit here feeling a little zesty percolation in my torso an hour before Apple’s FQ1 earnings release, I am humbled by the fact that the Nasdaq 100 has averaged a 25% annual return in the last five years. Very hard to beat that kind of performance over time (not that I assume it will continue to grow at this rate). If there is one thing I do think you can bet on, it’s that the Internet will get bigger, and technology will continue to be a driver of global growth for decades to come. So yes, I think we may join the other middle aged milktoasts, with the backbone of a chocolate éclair (to confuse food metaphors and borrow a phrase from Teddy Roosevelt), by moving most of our position in the next year into a diversified — though tech-heavy — ETF position. But we will still own some Apple, and I will still be cheerleading on the sidelines.
UPDATE: As everyone now knows, Apple absolutely crushed expectations … unbelievable results: http://nyti.ms/1EpeKOH
I just listened to the earnings call, and a few interesting take aways: Tim Cook said only a “low teens” percentage of current iphone users have upgraded, so most of the upgrade cycle has not yet begun; they saw a higher Android switch-over rate than in any prior new iphone release; and Cook reminded folks on the call that the vast majority of the world does not yet own a smartphone. This is what makes the Apple story so extraordinary — the biggest company in the world is growing at the pace of a startup, and there is a rational argument that this could continue for a few more years.
Though I think the company is positioned to continue to grow it’s fundamentals at a staggering rate for a few years, it’s likely that Apple’s buzz as the preeminent tech innovator will crescendo in 2015. And stock price, at least in the case of Apple in the last few years, is more tightly correlated with investor optimism than fundamentals.