The Case Against Apple

By Reid Holloway  APR 13, 2010 10:50 AM

Utilizing both fundamental and technical analysis, I see potential for some bad apples.


Editor's Note: To read more of Reid's content, visit the RLH Volatility Model.

The last thing I'd ever want to do is give Steve Jobs a hard time. Heck, the guy’s had a liver transplant. He’s also worth tens of billions of dollars and could crush me like a bug.

Apple (AAPL) is a gigantically important company whose magnitude cannot be overstated. It represents, in terms of its placement in the American economy, what the United States used to have in practically everything, and what the United States still has in certain things: overarching dominance (in Apple’s case, being first and best in the market with all things cool, technologically speaking).

This is important to think about because many people are worried about US leadership in the world economy, while at the same time Apple continues to dazzle the entire globe with success after success in both new products and updated versions of existing products.

I was joking with somebody the other day about the recently released iPad, acknowledging that I’d just read about half a dozen reviews. Nobody seemed to know what the thing does, I mused, but they all agree it’s got great battery life. That being said, the iPad ticked off some 450,000 or so units in sales in less than a week.

This is what Apple has been doing for some time -- and it reminds me of 1970, when Apollo XIII blasted off and, as the film starring Tom Hanks makes dramatic note of, TV audiences and networks didn’t take much notice of until the mission went awry. At that point, hard to believe, the American public had grown blasé over the incredible capability of putting people on the moon, despite what that huge capability reflected about America -- from its vast wealth to its technologies to our ubiquitous capability even then to tune into events in real time in aerial-broadcast color.

Apple’s stock is hitting all-time highs, and its market cap is surpassing or is poised to surpass the most venerable companies on the planet. Retirement accounts are loaded with it and the company’s customers may be the most dedicated fans ever known, including Red Sox Nation. Daring to criticize either Apple products or the shares is a reliable way to start a heated discussion and garner furrowed brows, scowls, arched eyebrows, cross words, and, I'd imagine, a few black eyes here and there. Some subjects don’t lend themselves well to objective conversation in many quarters, and that’s all true about Apple.

Meanwhile, the stock goes up, up, and up. Fundamentally, the company has earned consistently high praise over most of the decade of the new millennium. Of late, many analysts who hadn’t already accorded a maximum view of the company have done so. The few remaining who aren’t already on the pin of the positive-opinion gauge have notched up. And in both of those camps, there have been upward revisions in price targets. Some of these are in excess of $300. Technically, as well, the stock appears to be strong by various measures.

On the Other Hand…

There’s always that other hand, and the rest of this piece is dedicated to exploring that subject.

I should interject at this juncture that I’ve never understood why there's such an acrimonious division between fundamental and technical analysis.

Fundamental analysis avers that stock prices both individually and market-wide are a function of factors having to do with business economics and individual companies’ corresponding strategies, such as customer market size and penetration, growth rates, costs, profitability, and sales plans. “Softer” (i.e., not so quantitative) factors such as “management quality” are also heavily weighted and obviously therefore more judgmental.

Technical analysis takes an entirely different view -- at least it seems that way at first blush. This point of view looks at stocks and stock markets like tomatoes and the grocery stores in which they're inventoried and sold. You don’t need to know about tomatoes or the tomato business as such, just know instead everything about the demand for tomatoes and the supply of tomatoes, and you'll get an idea of the price and future indications. That’s why technical analysts are consumed with everything from charts to Kondratieff wave cycles. Generally, the fundamental and technical camps are known to look askance at one another, with the fundamental group the smugger of the two, being that they're generally more prestigious and more highly compensated -- including the top-rated sell-side brokerage analysts of Wall Street.

While I understand the enmity in that context, another part of it doesn’t make sense to me at all. After all, the fundamental tenet of technical analysis (yes, technical analysts have fundamentals in their racket!) is that what they do subsumes everything known about industries and companies in analyzing the trading actions of the marketplace for stocks, including the actions of those who produce and rely on fundamental research. Likewise, the fundamental view assumes that traders in the stock market will become attracted to or repelled by the fundamental conditions of the companies whose stocks they trade, thus affecting stock prices accordingly.

So the two groups actually include one another in mostly overlapping universes. Alas, I consequently wonder, why can’t the farmer and the cowman just be friends? After all, they’re just two squads on the same team.

Back to Apple

In the stock market, there is no God, and that includes Steve Jobs and Apple, even if that’s not a popular opinion. It’s a fact. And it’s true of every great company that’s had a great business and a great stock. Even Apple has had extended “dog days” most market aficionados have long since forgotten.

Just take a look at this graph.

Click to enlarge

Hard to believe, but that’s Apple’s stock during the 1990s, specifically, from the beginning of 1990 to the beginning of 1999. While the overall market was getting its teeth into a burgeoning tech boom leading up to the dot-com crash of 2000, this is what Apple was doing. It traded over 17 bucks (split-adjusted) in April of 1991, the high point of this depiction. On the last trading day of 1997, it wound up the year at $3.28 on the same split-adjusted basis. The longer-term and unisolated view of the stock going back to the fall of 1984 is far more impressive, and if you squint you can make out that 1990s segment we just examined.

Click to enlarge

In the above graph, you can clearly see why Apple is so thoroughly loved, despite those 1990s dark years. If you had invested even modest sums in this company in the mid-1980s, a feat within the reach of investors making far less money than the bank executives we’re always reading about, you did very, very well. And there are a lot of people out there -- individuals and institutions -- who did exactly that. They're very pleased, and I'm pleased for them, as well as for the company’s good fortune and all whom it has positively affected throughout the world.

As you can see, I’ve introduced some other quantities in this graph, the title of which makes reference to something technical analysts are often worried about. That worry is when volume doesn’t “confirm” price action.

One way to consider this concept is to employ the quantity known as dollar volume. It’s a simple monomial (math talk for something not very fancy, just multiplying one number by another -- no exponents, no logarithms). To compute dollar volume just multiply the share price for a given trading day by the number of shares traded. As you can see, Apple had toyed with the $200 mark at the end of 2007 and, from there, it slid substantially below the hundred-dollar mark during the March nadir last year, as most stocks also swooned. So, it’s not surprising then that dollar volume slumped too. But as you can also see, while the stock has soared to all-time highs more recently, the dollar volume still appears to be sluggish because the volume hasn’t been enough, even with that meteoric price action, to propel that quantity up to new highs. In order to know what this may portend, it seems to me that you'd have to take a look at what this type of action has corresponded with in price action of the past, so that’s what I did.

Before we leave this graph, however, please take note that I’ve also provided the increasing divergence between Apple’s price and dollar volume (light blue), and also graphed a moving average of that quantity to smooth out the picture (red).

21 Bad Apples

Here’s another angle on the long-term history of the stock, which I call 21 bad apples. It’s a snapshot in table form of Apple’s 21 worst one-day price declines over that longer-term history going back to the fall of 1984. And I’ve bolded that stagnant 1990s action.

The average tumult for these bad apples was a 16.2% decline. And there was an average of 430 days between each instance. Having made that latter point, it had been 560 days (until April 12, 2010, the day I prepared this table) since the last such bad apple of September 29, 2008, a date on which the stock declined almost 18%, some 30% greater than the average periodicity between bad apples shown here overall. In baseball, that might get a statistically oriented fan thinking “he’s due.” Is that the case? Can You See It Coming?

Again, let history be a guide but, as the mutual-fund prospectus always cautions, past performance doesn't guarantee future results. For this aspect of my discussion, I developed another way to highlight divergences between price and volume, but substituted an altered price-to-volume quantity employing a square-root function in the place of the dollar volume (simple monomials be gone!).

To avoid an audience-lethargy problem, I’m not going to go into exhaustive detail about all the calculations involved in this exercise, but I will share the game plan. And essentially that plan was to figure out a threshold criterion for isolating and observing 21 price-to-volume spikes to stand alongside the 21 bad apples above.

The results were striking. As expected (or at least it didn’t surprise me), I was able to identify two such spikes in 1991 and 1992 that could be alleged to have “presaged” the grim years for Apple’s stock in the 1990s. Much more unexpected and surprising, however, is that the other 19 spikes have all occurred during this year and 2009, notwithstanding the big correction last year followed by the big run-up since. My preliminary conclusion from these findings is that the stock should remain strong over the short term, with significant flattening two to three quarters or more out. Longer term than that, I'm far less sanguine, meaning such flattening could be prolonged.

Returning to Fundamentals

Here are my concluding thoughts about Apple at this time. While one thing Apple shares with most other stocks since late winter last year is that it has been going up -- smartly -- what it doesn’t share may be much more worrisome, and may also account for the “all-in” lackluster volume. Apple is in a class by itself, and that may sound good, and in many ways it is. But there’s a bad side too. Most stocks have been climbing a wall of worry about a shaky economy suffering a deep recession and high unemployment. Apple hasn't been doing that. No wall of worry at Apple. There’s too much love for that.

Yet it’s going up anyway. Along with 19 price-to-volume aberrations of the not-so-wonderful kind this year and last, including relatively low-price periods that should have kept those spikes at bay, and that also look a lot like the two in the early 1990s followed by “the dark years.” So if you say storm clouds can’t gather over this stock, the fact is they can because it’s happened before. That in no way means that the next 26 years can’t look as delicious as the performance since 1984 either -- just that it may also come with some long stretches of potholes.

Too Much Cash?

Another fundamental issue that gnaws at me about Apple is its cash problem, and Apple’s cash problem is both enormous and rather unusual, and not just because it has so much cash. What makes Apple’s cash problem unusual isn't only the amount of the cash but where that cash is (in a lot of international jurisdictions subject to high marginal tax rates if it’s drawn out), and the fact that everything amazing Apple does is organically developed (not acquired, the usual way to spend large sums of cash). On top of that, if Apple declares a dividend, it’s a whole new ballgame for the stock, and probably not a positive one relative to the past.

But Apple may be backing into a solution (or maybe it’s doing it deliberately; we shall see). Have you noticed the new pricing policy on the iPad? Apple will remain a partner with AT&T (T) for its data plans, offering 250MB of data for $14.99 per month, and an unlimited plan for $30 -- both without an annual contract. This reminds me a lot of when the courts granted universal access to the AT&T copper landline network back in the 1970s. The brass at MCI then joked, worriedly, “they’ve (AT&T) got us by the calls.” Yet AT&T didn't cut pricing as aggressively as its scale could have allowed it to, which might have knocked the new competitors into the grave at the outset. Perhaps they were too worried about more legal trouble? Or maybe too occupied with the divestiture of the Baby Bells? We’ll never know for certain, but what Apple is doing now with the pricing may be what AT&T didn’t do in the 1970s. Could that be an effort to solve not only the cash problem, but to get a huge double-whammy in market share too? Not only will we find that out in time to come, I suspect we’ll also see some substantial evidence of why fundamentalists and technicians usually travel the same ground as they reach similar conclusions about the stock while arriving at those conclusions by seemingly different yet not-so-different routes.

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No positions in stocks mentioned.

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