The Trouble with Tech & the Dethroning of Darlings
By Ilene
Sometimes, an investment strategy is more logical than successful in practice. For example, 10 years ago, investing in the personal computer space seemed like a great way to profit from progress. The three industry leaders, Microsoft (MSFT, $26.69), Intel (INTC, $21.25) and Dell (DELL, $11.06), all had promising future.
Paul Price (at Real Money Pro, subscription required) calculated that the 10-year EPS for MSFT, INTC and DELL grew by 180%, 144% and 62.5% respectively. Dividends increased from little or nothing, to 2.9% (DELL), 3.4% (MSFT) and 4.3% (INTC) over the same period.
These tech companies did well, but their share prices didn't closely reflect the growth in earnings. The P/Es got compressed. While Intel and Microsoft showed "moderately positive total returns," Dell dropped 60%. Paul determined that had we bought equal dollar weights of all three, we'd have less value now than when we started in 2003.
Charts by Paul (click on to enlarge):
As Paul also noted, "Other former technology high-flyers like Sony (SNE), Panasonic (PC), Nokia (NOK) and Research in Motion (RIMM) have been pretty disastrous in recent years as well."
Apple (AAPL, $523), on the other hand, has performed spectacularly well, up until several months ago. For those who bought Apple during the past year, it's a mixed bag. With Apple trading at around $523, buyers near the 52-week low ($419) are up around 25%. Those buying near September highs ($705) are down around 25%.
While AAPL's share price is high, its trailing P/E is only 12, reflecting skepticism regarding its future growth rate. Ten years ago, MSFT, INTC and DELL traded at P/Es of 25 to 30. Now their P/Es are near 14, 7 and 9, respectively. This P/E compression is typical of tech stocks as a company transitions from a growth to a "mature" company.
Joshua M. Brown described the situation in December:
"In the past week alone, Apple's seen $38 billion lopped off its market cap. With the stock closing at $509 yesterday, it's lost 200 points per share from the September high or $180 billion in total market cap. To put that into perspective, $180 billion is one McDonalds plus one Disney. It's Nike plus Starbucks plus Ford Motor plus Time Warner. This is a demented amount of lost capitalization for such a short period of time and in so healthy a company.
"The sell-off has been alternately explained as a tax-gain harvesting thing ahead of the Cliff (when it began selling off it was up 50% on the year and it's gained 8000% over the past decade). This morphed into concern over Samsung's continued market share gains which this week morphed into concern over a chilly reception for the iPhone 5 in China. And without a doubt, there are people who are now selling it for no specific reason; they're just getting out because everyone else is getting out…
"In the first half of 2012 it was the must-own stock, money managers had no shot of outperforming the benchmark minus an overweight to Apple. In the second half, this has completely reversed itself. The darling of summer is the pariah of the holiday season.
And now everyone who's associated with it is licking their wounds. I suspect the stock has to make a trip below $500 here, if only to test the depths of the sellers' desperation to be rid of it. The UBS analyst Steve Milunovich, whose target has declined to $700 from $780, has suggested that the shareholder base will now transition from growth guys to value guys. If he's correct here, that transition takes a long time – years, I've seen it at work." (Apple Cloverfield, my emphasis)
Paul noted that while MSFT, INTC and DELL may have provided ample trading opportunities during the past 10 years, they delivered poor to mediocre returns for long-term investors. Regarding Apple, he warned, "Technicians and short-term traders should welcome Apple’s day-to-day volatility. Those seeking safe and predictable total returns should take Apple’s well-publicized ‘bargain’ P/E as a warning flag."
So will AAPL turn into just another trading vehicle while it sinks to an inevitably lower price range?
In
- iPhone not the best anymore
- Competitors closing in
- Law of diminishing returns
- Overvalued market cap
- Product cannibalization
- Crowded trade
- Hypothetical new products, e.g. an iToilet, could flop
- End of cheap money from the Fed
"The numbers just don't add up for what is essentially a glorified hardware provider… It may be a creative and stylistic device maker, but in the end, it is in an industry exemplified by compressing margins and prices.
"In other words, the technology industry is a genre where prices and margins historically compress once new technology is introduced and becomes adopted by the masses, unlike education or healthcare where prices continue to escalate higher…
"But mark my word, there may be earnings surprises, and good quarters along the ride, but every jump in the stock will be sold into heavily, and the stock will continue to put in lower highs and lower lows as margins compress, and investors look for better opportunities in other areas.
"Eventually $400 appears in sight, then $300, $200, $100 and my target of about $50 a share as the company reaches the Microsoft, Dell, Hewlett-Packard, and Intel phase of a maturing Tech Company. Apple better have a hefty dividend by then or $50 will not be the bottom for this aging dinosaur."
Apple Inc. faces many company-specific challenges in the future. However, a $50 target seems way too low. The company has about $31 per share in cash and no debt. It's growing earnings twice as fast as the rest of the S&P and pays a 2% dividend. While Apple is probably transitioning from being priced for growth to being priced for value, it's not likely that it will run through its cash, lose its entire market share, or otherwise implode. The liquidity injected into the markets by the Fed is also not apt to dry up any time soon.
As Joshua Brown pointed out "Momentum works both ways and the trend has been a vicious one. The technicians won't touch it here on short-term time frames…and the growth-at-a-reasonable-price (GARP) gang is already all-in, they've been in and probably cannot buy much more unless they take in more dollars."
Our bottom line: AAPL has detached from trading on fundamentals in the near term, and as such is best left to the high frequency traders.
