Five cautions for Apple stock enthusiasts

CHICAGO Mon Apr 23, 2012 1:55pm EDT

The company's logo is seen on the Apple store in Washington October 6, 2011. Apple Inc co-founder and former CEO Steve Jobs, counted among the greatest American CEOs of his generation, died on October 5, 2011 at the age of 56, after a years-long and highly public battle with cancer and other health issues. REUTERS/Yuri Gripas (UNITED STATES - Tags: POLITICS BUSINESS)

The company's logo is seen on the Apple store in Washington October 6, 2011. Apple Inc co-founder and former CEO Steve Jobs, counted among the greatest American CEOs of his generation, died on October 5, 2011 at the age of 56, after a years-long and highly public battle with cancer and other health issues.

Credit: Reuters/Yuri Gripas (UNITED STATES - Tags: POLITICS BUSINESS)

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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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Comments (3)
Ronm88 wrote:
Apple may fall, and it can’t keep growing faster than the market forever. However, I think there is one thing that is very different between Apple and others that have “fallen” before. Apple’s PE ratio is relatively low, and Wall Street has already factored into its predictions that Apple’s growth will slow. That means that it should not have to meet lofty expectations in order to maintain its stock price. This is different from other high-tech darlings with lofty PE ratios.

Apr 23, 2012 2:35pm EDT  --  Report as abuse
ChKen wrote:
“All former stars have tumbled once they fell out of investor favor – often when their profits were still robust.”

Let’s look at these “former stars”, to see if your premise is true.

“share prices climb to lofty levels”

The problem here is that Apple’s share price has not climbed to “lofty levels”, unlike the other companies cited. There’s no comparison.

“How will Apple fare in the less charismatic, post-Jobs era?”

You do realize that this price run up has occurred in the “post-Jobs era?”

“Remember the “must-have” phone titans of the past such as Nokia, Research in Motion and Motorola?”

Superficial at best. Nokia was never a “must-have” in the US. RIM was all about email, and corporate security; as other phones improved their email and security, RIM lost its advantage. Motorola was a skinny phone. There was no moat. Certainly the iPhone can be disinter mediated, but basing your conclusion on Nokia, RIM and Motorola’s experience is shaky, as each failed for different reasons.

You could make the argument that Apple is a tortoise too. What other consumer PC company is still alive today, from the very beginning? HP? Any others? HP was almost spun off last year, so the healthiest of the original PC companies would be Apple. They won the PC wars, but most people don’t know it yet.

As everyone knows, comparing a market cap to a GDP is nonsense.

“How do you avoid buying stocks when they may be vastly overpriced?”

You have yet to show that Apple is “vastly overpriced”

There are some good points here about diversification, but trying to use Apple as a way to make those points didn’t really work out too well.

Apr 23, 2012 7:52pm EDT  --  Report as abuse
ARJTurgot2 wrote:
Seemingly forgotten now, is that the run up in GE value under Welch came in no small measure from the increase in value from the pension fund assets that were invested outside of GE. The market boomed, the pension fund value went up, so the company boomed, so the market boomed… Until it didn’t, but he was gone by then. Now he dispenses management wisdom for Reuters – Who says there are no seconds acts. Diversification is the closest thing to a free lunch. I have apple in my lunchbox, but it’s in a very small portion.

Apr 26, 2012 1:18pm EDT  --  Report as abuse
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