Tuesday, May 1, 2012

What To Do With Apple Stock?

If there is one challenge for institutional equity investors these days, it is trying to figure out how much, if any, portfolios should hold in Apple (AAPL).

Apple currently represents 4.3% of the S&P 500.  If you didn't hold Apple in your portfolio in the first quarter of 2012, you probably underperformed the benchmark.

Apple rose almost +50% (!) in the first three months of this year, and contributed almost +2% to the S&P's overall gain of +13% in the first quarter.

Apple's stock price has come off slightly since the end of March despite posting almost unbelievable first quarter results.

Still, with the incredible sales momentum the company currently enjoys (just ask  Nokia, which is suffering great losses at the hands of Apple), it seems hard to bet against the company.

Relative to its growth rate, Apple is a very cheap stock.

AAPL trades at just 12x earnings, which is near the lower end of its valuation range; the last time it traded at this level was in the spring of 2009, in the depths of the U.S. recession.

The company now offers investors a 1.8% dividend yield.  Given the fact that it ended the first quarter with an incredible $110 billion in cash, it is an understatement to say that the dividend has room to expand.

But there will be a time to sell Apple, as is true with most stocks.

If nothing else, the "law of large numbers" will begin to work against the company. 

Apple is now the largest company by market capitalization in the U.S.: nearly $550 billion, or more than IBM and Microsoft combined. While it is obviously an amazing company, for example,  it is hard to imagine any company growing to be worth $1 trillion.

So it was with interest that I headed over to Barclays yesterday to hear Ben Reitzes, who follows the Information Technology (IT) hardware space for the brokerage firm, which of course includes Apple.

I have written about Ben before on this blog.  He is a first-class analyst, and is not afraid to hold contrarian views on the stocks he follows.  His conclusions are based on numerous studies not only of the financials but also on regular "field checks" as a reality checks.

Ben has had a "buy" on Apple for 7 of the 10 years that he has been following the company.

While he acknowledges that Apple's huge market cap presents a significant challenge to further stock appreciation, he continues to believe that investors should be buying the stock.

He has a price target of $750 on the stock, which represents another +27% upside if he is right.

Ben argument is simple:  the IT space is now dominated by Apple.  The company has created such a dominance in the internet ecosphere that it is hard to imagine any company seriously challenging Apple in the foreseeable future.

In his view, the IT world breaks down into three sectors:  Apple, and companies that work well with Apple (especially EMC); those that are the big losers in the fight against Apple (Dell and Nokia especially); and those that are not directly impacted by Apple but probably will not enjoy the same rate of growth as Apple (IBM comes to mind).

So, Ben, someone asked:  When should you sell Apple?

In his view, there are two main risks.  First, at some point the company's dominance will attract the attention of the U.S. Justice Department.  Anti-trust investigations derailed Microsoft in the 1990's, and IBM before that, and the day will probably come when Apple's size attracts legal attention as well.

Second, if Apple's legendary customer service ever begins to falter, Ben would start to worry as well.  Right now, going to an Apple retail store remains for most people a "wow" experience; if this attention to customer satisfaction gives way to complacency, Ben would be a seller of the stock.

But for now, Ben says, hold on for the ride.