Five cautions for Apple stock enthusiasts
CHICAGO (Reuters) - As Apple announces its 2012 second fiscal quarter earnings on Tuesday, some analysts think the stock price could hit $1,000 and the company reach $1 trillion in market capitalization. I have no idea where Apple's price is going or what's in its secretive product pipeline, but I suspect that even with strong recent earnings, it will eventually fall from the tree it's on now.
What troubles me most are stunning similarities to other Wall Street darlings of the past and the ignorance of risk that owning a single stock carries. All former stars have tumbled once they fell out of investor favor - often when their profits were still robust. Here are five cautions worth considering:
1. THE MIGHTY FALL
The trajectory usually looks like this: A company with a stellar "story" is declared magnificent and graces the covers of business magazines. Expectations build, and share prices climb to lofty levels. Then the bottom drops out. This happened to any number of companies in the past decade or so - Intel, Cisco, Microsoft, etc. Although some analysts still believe Apple is undervalued and could rise higher, that observation doesn't always translate into a linear ascent, nor does it eliminate other risk factors.
Far too many investors buy in at extravagant valuations and typically hang on when prices fall and the companies are no longer in the spotlight. You can only remain a star for so long in the 24/7 cyber-infotainment world.
2. INVINCIBLE LEADERS LEAVE
General Electric CEO Jack Welch owned business headlines in 1999, when he was crowned "manager of the century" by Fortune magazine. Under his stewardship, from 1981 to 2000, GE revenue soared from $28 billion to $130 billion.
Despite creating a diversified conglomerate of businesses from financial services to appliances, though, the company became less popular with investors by the dawn of the 21st century, and the stock price fell by more than half. GE now trades around $19 a share. Did the loss of their uber-leader cause the fall, or did investors simply want another superstar company to adopt? How will Apple fare in the less charismatic, post-Jobs era?
3. TORTOISES SURVIVE
Sure, Apple has some great products now, but you can't deny the brutal global competition it faces. Remember the "must-have" phone titans of the past such as Nokia, Research in Motion and Motorola? The more visible the technology, the more volatile it is. In 1972 a group of highfliers called the "Nifty 50" dominated business pages. These "one-decision" stocks included Xerox and Polaroid.
Which companies of that era best survived technological shifts and the dismal late-'70s/early-'80s bear market? Consumer brands and pharmaceuticals were the best performers after the 1972 peak. They included decidedly unglamorous companies such as Gillette (acquired by Procter & Gamble in 2005), Coca-Cola and Johnson & Johnson. People still buy lots of soft drinks and other consumer and medical goods. As for Xerox and Polaroid, does anybody ever mention them anymore? While both companies seeded mini-revolutions, the world moved on.
4. BEWARE THE POISON FRUIT
Whether it's an earnings disappointment, botched product or failure to outpace the competition, Apple will not be immune to worms in the future. Since it's one of the largest constituents of the S&P 500 index, investors from Beijing to Boston are watching it closely, perhaps too closely. Expectations are major drivers of stock prices, but they can evaporate at the speed of light.
5. THE EXPECTATION CLIFF IS STEEP
Because of its gargantuan market cap - roughly larger than the entire gross domestic product of prosperous Switzerland (2011) - Apple has gained a demanding global audience. Does that mean its stock is less risky because so many people own it? The opposite is true. There's a lot of downside that few cheerleaders talk about. It can plummet when market sentiment reverses.
Don't mistake my observations on Apple as sourness about the stock. It may do very well and exceed expectations in the short term, although I'm always chary of the outsized risk of loading up on a single issue.
"Great companies are priced to perfection," Larry Swedroe, author of "Investment Mistakes Even Smart Investors Make and How to Avoid Them," told me recently. "So there is little room for any upside surprise. If everything goes as expected, you get low returns (because of the low-risk premium). On the other hand, if almost anything goes wrong, the risk premium might rise sharply, and the stock could fall dramatically."
How do you avoid buying stocks when they may be vastly overpriced? Consider a basket of equally weighted stocks like the Guggenheim S&P 500 Equal Weight ETF that spread out market risk. The PowerShares FTSE RAFI US 1000 portfolio takes a more fundamental approach by buying more bargain-priced stocks with dividends.
It's always important to put every stock you own into perspective and get a more enlightened view on how best to allocate risk in your portfolio. The idea that any one company, industry or even country can indefinitely sweeten your portfolio is still rotten to the core.
(The author is a Reuters columnist. The opinions expressed are his own.)
(Editing by Beth Pinsker Gladstone and Prudence Crowther)
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