Why Bill Miller Turned Bullish on Apple
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The Fiscal Times
April 19, 2013

A year ago, Apple (NASDAQ: AAPL) was the biggest, brightest, shiniest stock in the market, with analysts competing to boost their price targets to $700 a share and even higher, forming what some Wall Street wags rapidly dubbed the “700 Club.” Sure enough, Apple briefly topped that level early last fall – only to promptly begin a steady decline that now has totaled some 45 percent and has culminated this week with a two-day drop that has dragged the stock price below $400 a share – a far cry from $700.

It will be four more days before we get Apple’s earnings for the first three months of 2013. Already, however, investors clearly are bracing not only for a disappointment but a near disaster. But next week’s earnings release may also represent a turning point, as veteran Legg Mason fund manager Bill Miller told me recently for a Wall Street Journal story.

As investors have seen about $260 billion in value evaporate from Apple’s market capitalization, the company has gone from a “must own” position (a holding not to be shunned by any investor or portfolio manager who wanted to stand a chance of beating the index) to the kind of stock that makes potential investors wrinkle their noses in distaste. It’s proving to be a drag on technology stocks as a group, too: If you exclude Apple, the sector is up 3.74 percent since September, when Apple topped $700 a share – but if you add in the erstwhile tech favorite, the group is down 7.77 percent, as of Wednesday.

The problem is that Apple’s stock price growth had outstripped its ability to continue to deliver hefty sales and margin growth. Myriad disappointments – on sales figures, on overall revenue, on earnings, on margins, or combinations of these – have plagued the company’s earnings for much of the last fiscal year. In the year-ago fourth quarter, Apple sold 37 million of its iconic iPhones.

But when audio chipmaker Cirrus Logic Inc. (NASDAQ: CRUS) reported this week that an excess supply of its main product will take a toll on sales and margins, that prompted the latest selloff. Cirrus is a major supplier to Apple and, the logic ran, its announcement signaled that Apple itself may be staggering under a glut of iPhones that it can’t sell. Toni Sacconaghi, an analyst who covers Apple for Sanford Bernstein & Co., cut his estimate of iPhone sales for this year’s fourth quarter (ended March 31, 2013) to only 34.2 million devices from 35.2 million previously.

Apple’s iPhones and iPads certainly are vulnerable to competition, as rivals emphasize lower price points and more options. The once-insatiable hunger for the very latest Apple gizmo seems to have abated somewhat – the iPhone is no longer a bleeding-edge product – and as a result, Apple’s last quarterly earnings report included its slowest rate of profit growth in almost a decade.

Apple’s new world is a decidedly less pleasant place than it was a year ago. It has ceded its status as the market’s single largest stock to Exxon Mobil (NYSE: XOM). Its market capitalization today has fallen well below $400 billion – compare that to relatively stodgy Microsoft (NASDAQ: MSFT), which has a market cap of $243 billion. Since Apple’s dividend yield is still only 2.6 percent, that may well make Microsoft, which offers a yield of 3.2 percent, look more appealing to some investors. Certainly, the market is willing to pay more for every dollar of profit that Microsoft generates: The software company trades at 15.7 earnings. While Apple historically has traded at a premium to the S&P 500 (and continued to do so until about midway through 2011) today it trades about 9 times trailing earnings, about two-thirds of the value of the market benchmark.

Apple’s stock price relative to forward earnings estimates is almost bizarre – the multiple of 6.8 is the kind of figure you might expect to see in a struggling company fighting for its survival. (By some calculations, BlackBerry (NASDAQ: BBRY), which has still to persuade customers that its new Z10 smartphone will give the company a new lease on life, trades at 21 times forecast profits.)

All in all, that’s a rather remarkable reshaping of relative values, especially for a company that continues to see its earnings and profits grow at a greater rate than the S&P 500 index itself is able to boast. That kind of pricing implies that the market expects Apple’s profits to decline by 40 percent or so.

Odds are that Apple will report some kind of earnings disappointment next week – or at least, that investors will find some reason for disappointment in either the numbers or in management’s discussion of the results. Maybe it will be something tangible, such as the number of iPhones shipped or management’s comments that a dip is to be expected in iPad mini sales ahead of the release of the next-generation product. Or maybe it will be something as vague as investors deciding that they aren’t happy with the way CEO Tim Cook discusses the next generation of products (perhaps their timing, perhaps their features) or what new products are being dreamed up by the Apple innovators.

The good news in all this is that so much bad news is now priced into the stock that it’s going to be fairly tough for the company to deliver a real disappointment. The more subdued growth rates are hardly surprising: How many companies can sustain the kind of growth that Apple did, year after year, for more than a decade?

Perhaps it’s no wonder that the legendary Miller has become one of Apple’s new admirers. Miller knows what it is to outperform and fall from grace. He is famous for turning in returns that beat the S&P 500 for 15 calendar years in a row – only to snap his winning streak, eventually, and see at least some of his former fans throw their arms up in dismay and horror.

Once next week’s earnings release is behind the company, Miller – who has added Apple stock to portfolios he manages in recent weeks – says some of the headwinds will vanish. “No one wants to buy before the news hits,” he told me at the beginning of April, well before the Cirrus Logic report was released. Once Apple’s earnings news – good, bad or indifferent – is out of the way, Miller said, he sees upside ahead. He’s confident that Apple will produce some kind of plan to address shareholder restlessness about the company’s gargantuan $137 billion cash mountain, perhaps including a dividend increase. “The bad news will be gone, new products will be out; the stock price will go up as people focus on the dividend increase,” Miller said.

Certainly, what is happening right now seems to be as much about market psychology as it is about fundamentals. Perhaps Apple was never worth $700 a share, but neither should it be trading at such a whopping discount to the overall market without the business being under some kind of serious competitive threat.

True, Samsung is making inroads into the smartphone market by offering an array of devices that appeal to consumers across multiple price points, but that’s not the whole story. To be as bearish about Apple as many appear to be today would require being convinced that the company lost its mojo with the death of founder Steve Jobs and will never again be able to launch a pioneering, or category-killing, product. Investors will need to decide whether that’s a riskier bet than jumping into the stock at a time when the market appears as reluctant to see any upside potential as it was to contemplate any risks a year ago at this time.

Business journalist Suzanne McGee spent more than 13 years at The Wall Street Journal before turning to freelance writing. Author of the book Chasing Goldman Sachs, she has written for Barron’s, The Financial Times, and Institutional Investor.