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Tuesday, 12 March 2013 17:48

Apple’s Crime and Punishment

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buy-panic-sell-buttonsPreface:  Given the large number of articles available online that outline virtually every conceivable method of analyzing the quantitative factors of AAPL, the following aims instead to approach the subject from the more subjective, human aspect.

 

“Pain and foolishness lead to great bliss and complete knowledge, for Eternal Wisdom created nothing under the sun in vain.”

- Kahlil Gibran

Emotions, Humanity and Investing

 

Andy Zaky is human if emotional.  Even if he did loose what may have been billions of investors’ money on AAPL in what on the surface seems extraordinary and easy to criticize.   Although it may take a bit more intellectual creativity to imagine, it must be concluded after careful examination that even Florian Homm is human. 

 

However, perhaps unknown to Mr. Zaky, in his tale of initial triumph, failure and ultimate disaster are the answers so many are seeking about the future of Apple.  That is to say, at least in the near term, the price movements in the shares may be subject to extremes because of the type of buyer and seller the shares attract.

 

To be fully human is to be emotional and emotions have no place in successful investment management. To have no emotions is in a way to lack some part of what constitutes humanity, and though an advantage in the analysis of securities, comes at a heavy price to the afflicted.   

 

It seems that when the emotional development of a mind is underdeveloped, the rational propagates, not unlike the way in which a blind man’s hearing develops beyond that of the seeing.  Somehow humans are so elastic and extraordinary that when some aspect of their being is stifled, particularly early in life, some other aspect compensates or maybe “over-compensates”.

 

LVBLudwig Van Beethoven and Warren Buffet are notable for the curiosities of their inter-personal relationships, it may be for the exact reasons above.  The two examples must have known something about how trauma in early life can arrest development in one area, while some other aspect of the mind develops beyond the boundaries of what society can easily comprehend. 

 

The Intellectual Value of Understanding

 

“Not only did these people get some spectacularly bad advice, but they got it from someone whom I helped make famous”.

Philip Elmer-DeWitt, March 4th, 2013 Fortune

 

Zaky and Fortune editor Philip Elmer-DeWitt deserve credit for being contrite and honest.  Is it possible that Zaky merely represented a pre-existent element of excitement and adventure in speculation involving shares of AAPL that had little to do with real investment and thus accountability is easily extended from management to investor, and perhaps editor?

 

"As a first generation Coptic-American, I was raised with very deep seeded (sic) traditional notions of honor and responsibility. For this reason, I will spend every living breath I have to work with an effort to make our partners whole again...”

 

"I am deeply sorry that I failed you. I brought dishonor to myself and my family, and all I can do at this point is work hard to try and make things right."

Andrew Zaky

 

It has been said “to err is human; to forgive, divine.”  But why forgive, why not “get even”, even if only through the writing of sharp pros as many authors have done? 

 

forgive-your-enemiesWithout this understanding the prospective purchaser or seller of shares may not fully benefit from what has transpired.  Of course there could be other equally compelling reasons to forgive.

 

It takes Character and Self-Control

 

“Any fool can criticize, condemn, and complain but it takes character and self-control to be understanding and forgiving.”

Dale Carnegie

 

Good can come from the tragedy suffered by those involved (which includes Mr. Zaky and Mr. Elmer-DeWitt), if it serves as a reminder of the dangers of stocks which attract large numbers of visceral traders. Voluntary humility occurs when one has “one foot in the grave”, prior to that time there is a plenitude of involuntary openings.  Exposure, attention, and the promise of the sudden creation of wealth must be a seductive and even addictive cocktail to those whose emotions are in-tact, while hubris, the less subtle companion of pride clouds the mind.

 

Hedge fund managers, like retail investors, are left entirely to their own devices (or perhaps just vices).  The market of retail brokerages which cater to the later group while far more subtle and sophisticated than the present example, do help the majority of their clients part with their money over time nonetheless, if by no other means than the prompting of an astonishing number of transactions.  Perhaps what makes the current example most poignant is the unpleasant thought that many readers of AAPL articles could easily have been Mr. Zaky’s clients or (if under the right convergence of events) even in his shoes. 

 

There must be many incidents similar in nature involving shares of AAPL which have gone unreported since it is not exactly the type of outcome one hopes to advertise.

 

The fact is that the percentage of managers or investors who experience no emotions whatsoever in the execution of investment decisions is amazingly small.  For the rest, it is not unlike the perfectly upright citizen who reads Dostoevsky great work and for a frightful instance acknowledges the legitimacy of the question briefly considered in his private thoughts; “if under the right confluence of circumstances… could I…?”

 

Perhaps many managers and investors alike read the story of Mr. Zaky and for an unpleasant second asked the same question which his former investors already know the answer to.  

 

The markets are often infected by the wild extremes of speculators.

 

The Short Seller and his More Popular Cousin

 

“What a fool does in the end, the wise do in the beginning”

-Proverb

 

The short seller is loathed because it is thought that he profits when the other party to a trade loses – and he does.  However upon more cautious consideration he is simply selling when others are inclined to buy and buying when others are content to sell. 

 

But what is possibly overlooked is that those who go "long" also profit when others lose, yet they are viewed as virtuous, although their activity is identical to that of the short seller, and varies only in temporal order for it must be acknowledged that the successful of the genus purchase shares from sellers for whom it is not in their best interest to sell and subsequently sell to those who shouldn't be buying.  This activity is carried out with precisely the same intentions as his close relative the short-seller. 

 

Therefore, the question ought not to be on the ethics of dealing in long or short positions, but rather the wisdom of the trade, regardless of how it is executed, it should not be forgotten that layered on top of these trades of equal intention is the extraordinary leverage possible through the amplification of derivatives.

 

A knowledge of Good and Evil

 

“…a good reputation is a great burden and mine is already hopelessly tarnished.  I can afford to be honest…”

Florian Homm (Rogue Financier: The Adventures of an Estranged Capitalist)

 

There is a bite missing from AAPL’s logo. 

 

Mr. Zaky was bullish on some “Cross” (the website is called “Bullish Cross”), not sure what it means because specialists of technical analysis are probably too intelligent for the more simple minded value oriented managers to figure out their code.  But there is at least one hypothesis; for some two thousand years it has generally been recognized that a “Cross” usually is a symbol, amongst other things, of sacrifice, truth and redemption.   It has been said that with faith this symbol can undo the lethal effects of a bite from a certain forbidden fruit that had something to do with the knowledge of good and evil – a commonality in every person’s ancestry.

 

It is impossible to forecast the future price of AAPL, but much can be gained of far greater value.  The truth rarely emerges on Wall Street and when it does it is worth listening to, no matter how unlikely the source.   The reality about AAPL is no matter how far the present value exceeds the quoted price the shares remain a favorite of speculators, who are the primary operators in the shares.  Since speculation is irrational there is no way to quantify its limits.

 

There have been many financial models to compute the supposed future value of AAPL, but none have offered to measure the effects of irrational behavior on the share price so well as that provided in the confessions of Mr. Zaky and Mr. Elmer-DeWitt.

 

Every Action has a Reaction

 

At current prices (~$425) the shares appear to represent just the sort of investment opportunity that a shrewd value investor such as Buffett or Munger would find attractive.  However, Buffett and Munger are not good examples for the average investor to follow since they have some “Ten of Billions” of dollars to put to work.

 

It is not a stretch to imagine that the overwhelming majority of readers of articles on the value of AAPL have somewhat fewer zeros to worry about on their brokerage account statements.  Given this, the question “what would Buffett or Munger find attractive" is probably not the right question, particularly since their stated timeline is “forever”, a distance in time considerably greater than the average investors.

 

Needless to say, the 40% drop in price did not go unnoticed.  It looks as if there are a few different eventualities of this event:

 

1.  Value investors (a categorical minority) will notice, and finding value may buy.

2.  Speculators (a categorical majority) will notice and fearing a more prolific exit may yet sell.

3.  A great many retail investors who would have passively owned the shares but do not regard or understand fundamentals will decide it is better to “keep the diminished gains, despite the recent discount” and sell – i.e. acquiescence or capitulation.

4.  A large number of more recent owners, the greatest percentage of which will also neither understand or care about the fundamentals will have negative feelings associated with the shares, perhaps for the remainder of their investing careers.

5.  Institutional managers may feel a need to do what their peers are doing, and having basically the same feelings as the average retail investor may become uncomfortable with a position which places them in opposition to [a perceived] majority.

6.  Some may reason that since the shares had increased in value for so many years, that six months does not seem like a significant amount of time for a correction.

 

The first group may buy on the news of such a substantial discount from prices only six months ago, but the later five, preferring the comfort of the crowd and unfamiliar with the comfort a thorough understanding of the financials can provide, are just as likely to keep selling or otherwise avoid the shares.  In such a circumstance it does not pay to be in the minority.

 

Not withstanding this, many who have suffered losses in the last six months, and still own the shares may want to know what the good news is.

 

There is no shortage of impressive and complex spreadsheets available in the never ending stream of commentary available online attesting to all of the fantastic methods available for discerning the “true” future value (or in some cases, price) of shares of AAPL.  Providing more analysis on what must be the most analyzed company in history might be over-kill and given the human-bent above, it seems that the following simple examples will suffice for the present exercise.

 

Extremely Well Capitalized

 

Its been said before – AAPL is extremely well capitalized.  However, it is a bit more fun if the analyst considers moving long term investments to short term to get a handle on NCAV (net current asset values).  Why?  AAPL can barrow at probably next to nothing against these assets  if greater liquidity were really needed – this provides a 25% NCAV value at~$425 per share (or ~$107.45 per share - this figure does not utilize the stricter "Graham" approach) which is extraordinary for a company of AAPL’s  size.   However it is not on the whole unusual for a publicly listed company.  

 

After a four year bull-run a focus on the balance sheet may be of uncommon importance, and there are other smaller companies available with higher NCAV values, and equal growth.  The size of the company in this case is extremely relevant as smaller concerns, in general, have the ability to continue higher rates of growth (given the difficulties inherent in such economies of scale).

 

Growth in per Share Book Value Impressive

 

The ability to grown per share book value in aggregate by 48% over the last six years is extraordinary.  The growth in equity overall was even more impressive at 51% (although this also reveals the dilution that took place for longer term owners).  Very few companies can boast either metric, and even if there are no blockbuster products in the pipeline, AAPL may be able to continue this performance for years to come if cash is allocated to significant repurchases and the price remains low or declines further. 

 

The Math:

Fig. 1 - AAPL Growth in Per Share Book Value

Growth in Per Share Book Value

%   Increase

Value

     

2006

 

$               11.83

2007

42%

$                16.81

2008

42%

$               23.85

2009

49%

$               35.43

2010

48%

$               52.55

2011

58%

$               82.89

2012

52%

$              126.00

2013 Q1

 

$             136.00

12 month forecast

 

 

   

 

Avg:

 

48%

Avg. w/   dividend:

 

48%

   

 

 

 
Over ten years the growth in per share book value has been 6,054.18% but price has accelerated at a somewhat faster pace since 2009 as illustrated below:

aapl price vs bv


An Astonishing Company before an Unexpected Opportunity


Can technology meant for the masses be turned into a truly enduring brand?  Few company’s in history have enjoyed the cult following that AAPL has, but will it last?  Nobody knows, but if ever there was a company that could create the “Ferrari” of technology (if that’s not a contradiction), that is to say something as admired for its quality as its ability, then AAPL must be it.  Yet Ferrari is meant for the few, and in their limited supply appeal to the majority as the “exclusive” content of desire.  How can this be transferred to the economies of scale which AAPL now faces?   Microsoft and Google have extremely strong brands, but never have had quite the cult following of AAPL.  These companies appear to build “need” more into their products, but AAPL has built desire – and desire is more transient and emotive than “need”.  MSFT for example has greater operating margins than AAPL, and yet over the last year the share price has declined some 12.88% and declined some 4.82% in the last 5 years while shares of AAPL have increased in price by some 243.83% (after the recent decline).   A key difference may be that MSFT, although often needed has spurred little desire for its products.

 

msft price vs bv

The Next Blockbuster Product

 

ipad miniThe second half of 2013 may usher in the arrival of the next blockbuster product for AAPL, but if that is the driver of an investment decision there is no reason to wait until the announcement, because the current product is likely to be a as-yet-to-be-revealed blockbuster.  The iPad Mini is sort of like a new luxury car body style, at first it doesn't look quite right, perhaps even wrong, but then one day the eye sees what the designer meant and realizes that all along it was the viewer who was wrong and not vice versa.  Just such an experience may have been common with the new Mini, since its announcement, the idea did not seem good and the product wrong – indeed "lacking".  But the iPad  Mini is not the wrong size, there is nothing wrong about it, the traditional iPad is sized wrong.  Conversion can be nearly instantaneous… Jobs, who had not liked the idea either, despite his genius, was wrong.

 

The idea of a iWatch seems equally awkward at first… but AAPL may prove to be right again, if only one will imagine the fantastic ways in which AAPL may change the activities of everyday life with such a device, and a scheme which promises margins far in excess of the more commonly contemplated iTV.

 

There is no clear advice that can be given on the shares of AAPL given it’s extraordinary position in history and the variety of intentions of the investing public (especially those outlined above), however a few timeless principles of investment may be useful to more passive investors considering their position or prospective position in the company;

 

1.  Long term horizons are always better when a great company is owned. 

2.  Buying securities when the price is demonstrably below real value (an approximation will do), usually provides better than average results.

3.  If patience, focus and discipline are not “hard-wired” into decision making, avoid trading entirely.

 

For an enterprising value oriented investor on the other hand, it is hard to see how shares of AAPL will provide extraordinary gains over some of the secondary and smaller issues available from time to time in the market, and although a wonderful company with marvelous products, as an investment, unless there are 10 digits on your brokerage statement which need to be put to work, there are more aggressive bargains available often enough – AAPL is cheap, but it’s not “screaming” cheap.

 

 

 

Lemelson Capital Management

Lemelson Capital Management, LLC is a private investment management firm focused on deep value and special situation investments.  The firm’s flagship fund, The Amvona Fund, has been named repeatedly one of the world’s top performing hedge funds.  For more information, see: http://www.lemelsoncapital.com

Website: www.lemelsoncapital.com

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