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An Apple a Day

This is a sample adapted from a weekly update sent out to Dynasty Members.

Date written: January 7th, 2019


2019 started off with a bang ammirite?!

As you probably heard, Apple really brought down markets yesterday. The tech behemoth finished the day down 10%.

Interestingly enough, since it peaked in early October at more than $1.1 trillion in market cap, it is down nearly 40%. Yes, you read that right, 40%.

This was once the biggest company in the world by a fair bit.

There's two lessons here.

1. Big companies aren't always "safe."

2. It's unreal how fast the market can turn on a company.

The market is ruthless. Think about it.

In three months, just 90 days, Apple has lost roughly $450 billion in market cap. That's a Facebook and a Nvidia combined.

The market doesn't care if you have well over a billion devices sold world-wide or that you have $200 billion in cash. It cares about one thing and one thing only: the potential in the future for earnings growth.

The past doesn't give you a get-out-of-jail-free card. If anything, an impressive past hurts you because it gives investors' high expectations, which are harder to meet.

This is not so much a diatribe on the ins and outs of Apple (though it might turn into one), as it is not in the portfolio (if it drops 15-20% more I might reconsider because then it would be far too cheap in my opinion. While I rarely make deep value plays, I'm open to it because I've done a fair amount of research on Apple.).

But rather this is a lesson about conviction and how quickly the market can turn.

I wonder what's going through Warren Buffett's head. Apple is 23% of his portfolio. Does he just average down or is there an existential problem with Apple?

I would bet big money he is simply averaging down, but our strategy is typically different.

Ideally, I would like to average up as a company continues to perform well. This is counterintuitive because it goes against conventional wisdom to "buy low, sell high." When a stock goes down, on the other hand, that means the market thinks something is wrong. You may think you know more than the market, but it's tough to play that game.

There may be times where you do know more and you have the conviction, average down, and it works incredibly. It's just that I've seen so many investors, myself included, throw good money after bad for the sake of "cheap."

I would rather invest in the best, have a long time-horizon and a high opportunity cost.

With that said, it is possible for something to get "too cheap."

Nvidia, Facebook and Apple are all plausible examples right now.

I've owned each in the past but hold none as of now. What was once a trio of absolute powerhouses is now a mixture of pessimism and doubt. It's crazy.

As humans, our ability to extrapolate based on recent events is second-to-none. This can hurt us though. We think linearly; Apple is going down, therefore it will go down forever.

But what if Apple innovates and creates the next big consumer product?

A lot of predicting those things have to do with the qualitative aspect of a business: the culture. Is it innovative? Does it have a great track record of innovation? Does the culture foster and reward that?

These are tough questions to answer, but ones that are necessary to examine if you are looking at a turnaround situation.

Take Netflix for example. In late 2011-2012, the company announced that it was splitting up its DVD-by-mail service, named Qwikster, and its streaming service. Subscribers would have to pay for each one separately. Initially, the stock rallied, as investors were wide-eyed and greedy for higher average subscription values.

But the consumers spoke. No one wanted to pay for both. The stock, over the next year, would drop 80%. No joke.

Shortly into the debacle, Reed Hastings, still the current CEO responded,

"I messed up. I owe everyone an explanation.
It is clear from the feedback over the past two months that many members felt we lacked respect and humility in the way we announced the separation of DVD and streaming, and the price changes. That was certainly not our intent, and I offer my sincere apology."

Two notable lessons here (wow, so many lessons! This is fun!)

1. Pricing and distribution problems are easier to fix than demand problems.

Apple, to my eye (not of my eye), has a saturation problem, aka a demand problem. People aren't upgrading their phones. Plus, China growth is slow. In China, WeChat is all that matters, not iOS. So the biggest moat for Apple (its software) is not a huge factor in China. And everyone else in the world already has an iPhone.

So how do you grow earnings? Most likely, margins will increase as the services part of their business expands.

But this is compared to Netflix's problem of a bad marketing strategy. All it had to do was apologize, fix the subscription models and people still bought them. The demand was there.

With Apple, I'm not as convinced.

2. Transparency from management is critical.

That quote from Hastings sums it up. Full transparency.

On the other hand, Tim Cook blamed the Q1 guidance cut on "tough comps", "China economic slowdown", "an unprecedented number of new product announcements" and "a strong dollar."

He really hit on all the generic excuses. I'm being harsh but I didn't sense transparency. For one, it knew about the tough comp last quarter when he gave the original guidance. Two, China has been slowing for over a year. Three, what new products?? The Apple Watch 4? Nothing revolutionary. And four, a strong dollar, really? That's why you cut guidance $7 billion!?

Again, I'm being overly harsh but I just don't buy all of those excuses.

After reading this you might think I hate Apple. I really don't. It's one of the great companies of the past two generations. The services will continue doing well. And the stock is trading cheaply.

I'm just trying to look at both sides as best as possible and cross-reference this situation with past turnaround situations.

Phew! That was a lot. Thanks for reading. Let me know what you think about all of this. Or just tell me about what you're gonna do this weekend. Also, hope you enjoyed the podcasts. Leaving a review on iTunes would be super helpful.


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