Trade of the Week – Short Apple ($190.89)
- Apple is my largest individual short position
- Earnings growth is slowing, at the services component, in particular, and the marginal benefits from zero interest rates – and a low share price – of buying back equity is now diminished
- Apple's P/E ratio has risen from 10x in 2019 to almost 30x today
- Who is left to buy Apple?
Apple is the world's most beloved company and stock. The company's weighting in the S&P 500 has swelled to 7.6%, the biggest of any one stock in the history of the benchmark index.
I am in wonderment that Apple trades at such an inflated price-to-earnings ratio given its limited organic growth prospects and diminishing cash pile.
I am also in wonderment that Berkshire Hathaway (BRK-B) owns 916 million shares worth $175 billion, and accounts for nearly half of the company's $375 billion equity portfolio. Margin of safety, Warren?
The valuation reset higher in price-to-earnings multiples at Apple (and for the broader markets) speaks volumes about the current stock market, and what has happened in the economy with low interest rates and how capital was deployed. Sadly, low rates mean capital goes to the financial/asset economy as opposed to the real productive economy.
Note Apple's net cash as a percent of market cap. It has plummeted over the last 10 years from 35% down to only 2%! There is a numerator and a denominator issue.
As far as the numerator goes, the company has gone from debt free and cash rich to now carrying a fair bit of debt. The debt was issued when the cost of debt was quite low, and the cash proceeds could be redeployed into buying back stock. To Apple's credit, using their cash flow along with the financial engineering, they have retired a fair bit of stock, which appeals to The Oracle of Omaha.
But now it seems like the jig is up on the scheme. With the stock price where it is, it takes a lot more cash to retire a share. With rates where they are today (compared to March 2022 when rates were basically zero!), it is less attractive to sell debt to do this. With the multiple where it is and the interest one can generate from cash on the balance sheet, the math becomes even less compelling.
There are now diminishing marginal returns to the debt issuing and aggressive buyback scheme that has been such a powerful tool for the equity performance of Apple's stock. To be fair, I guess they can keep going – with still high internal generation of excess cash – and sell debt at higher rates, and turn themselves into a levered entity, but with the multiple where it is, this is more of an act of desperation as opposed to wise and real value creation.
I remain surprised Berkshire/Buffett still owns so much stock here given the math doesn't work like it once did. For a company that increases earnings per share by buying back stock, a high P/E multiple can work against you. It seems that the best they can do now is run in place to stand still.
As far as the high P/E multiple is concerned, this is where it gets interesting. Apple's growth has slowed substantially. The last reported quarter, they shrunk 3%, with the benefit of a fair bit of inflation. Their wildly hyped "growth engine" of services sharply decelerated to only 5% year over year growth, down from 17% in the same quarter last year. It will eventually match the growth rate in their handset installed base, which seems close to zero – and it could be worse depending on how some of these lawsuits play out regarding the high fees they charge for their app store.
They don't innovate. They just invest in buying back stock. Because of this, there is no new growth engine to drive future growth. The first new product in years, their version of the Meta's (META) Facebook goggles that nobody seems to want, are finally coming to market about 15 years after the category came into existence (Facebook acquired Oculus Rift in 2014, and Oculus had been around for years prior to that developing the product).
Interest rates are also higher now, by a fair bit, which should also depress stock multiples.
Yet, with all of this going on – higher interest rates, slowing to negative growth, no innovation, buyback math substantially diminished – their P/E multiple (chart below) has expanded to around the highest it's ever been, and much higher than it was when the company was actually a pretty decent grower. The most recent almost 50% jump in the stock, with all these negatives going on, is due entirely to multiple expansion. This speaks volumes about the market, which is really only five to eight companies.
Nvidia (NVDA) at least to their credit, innovates and had a huge upside surprise. Apple did or does neither. It just goes up I guess, and the same can be said about five to seven other companies, to which I say better lucky than good.
Apple's Cash Positioning Is Dwindling
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While Apple's Valuation Is Inflating
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Bottom Line
Things for Apple are about the worst they've ever been for the company in the last 10 years – growth, balance sheet, share buyback mechanics, view of future ability to grow due to lack of innovation, and a very saturated and mature core market – yet the stock has now returned to the peak P/E multiple it had during the COVID rip, and we know how that ended...
At least during COVID, the company was growing quite robustly, just like every other stay-at-home company, plus rates were 0%. Then, although Apple's stock price and multiple were silly, they were a lot less silly than GameStop (GME) and Peloton (PTON), for example.
It appears that all the GME and PTON money has now crowded into Apple and five to seven other stocks. The professionals have followed right along, once again, and a viscous cycle has been created between the groups of chasers at each end of the barbell.
It is a mania again, of a different sort.
This one really is perplexing though because there is no real identifiable proximate cause. It just sort of happened, without a clear and obvious growth catalyst, and is confined somewhat narrowly. Now, along with select others, right back to the P/E it had during peak Covid insanity, with virtually everything working against it except for the most important and unidentifiable thing evidently working for it.
D Kass
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