Discover the pressing reasons behind one investor's decision to go underweight on Apple, the tech behemoth that dominates market conversations and the S&P 500. In an eye-opening discussion with our host Clem, we unravel the subtle indicators of Apple's wavering market grip. Join us as we peel back the layers of this financial conundrum, offering a fresh perspective that challenges the status quo of investment strategies.
This episode is a treasure trove for those who seek to understand the intricate dance between consumer behavior, technological innovation, and market influence. Clem, with a mere 1.8% stake in his portfolio, brings to light Apple's stagnating revenue and earnings growth, and the lukewarm reception of the iPhone 15. We scrutinize the formidable headwinds Apple faces in the Chinese market, including the stunning advancements of Huawei and the government's tightening restrictions. For investors and tech enthusiasts seeking a skeptic's insight into the future of this industry titan, this conversation is an essential listen.
Discover the pressing reasons behind one investor's decision to go underweight on Apple, the tech behemoth that dominates market conversations and the S&P 500. In an eye-opening discussion with our host Clem, we unravel the subtle indicators of Apple's wavering market grip. Join us as we peel back the layers of this financial conundrum, offering a fresh perspective that challenges the status quo of investment strategies.
This episode is a treasure trove for those who seek to understand the intricate dance between consumer behavior, technological innovation, and market influence. Clem, with a mere 1.8% stake in his portfolio, brings to light Apple's stagnating revenue and earnings growth, and the lukewarm reception of the iPhone 15. We scrutinize the formidable headwinds Apple faces in the Chinese market, including the stunning advancements of Huawei and the government's tightening restrictions. For investors and tech enthusiasts seeking a skeptic's insight into the future of this industry titan, this conversation is an essential listen.
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Steve Davenport:
Hello and Happy New Year. Welcome to another episode of Skeptics Guide to Investing. On this episode, we're gonna talk about Apple, no, not the fruit of the stock. As I'm sure you all know, Apple is a stock in the S&P with the highest weight, about 7% Clem. Do you own Apple in your stock portfolio and at what weight?
Clem Miller:
So, Steve, yes, I certainly do own Apple. I think that obviously a lot of folks own Apple, but I'm actually quite underweight Apple. As you mentioned, apple has a 7% weight in the S&P 500 as the highest weighted stock. I have 1.8% of my portfolio in Apple. So really I'm quite underweight the stock and I have some reasons why and we can go into that.
Steve Davenport:
Clem, so you're underweight Apple relative to the S&P. What are your main concerns?
Clem Miller:
About Apple, so I'm really mainly concerned about its revenues. Its revenues have declined by 3% over the last 12 months. The market seems to be expecting only about 5% revenue growth over the next year and the market's always sort of optimistic about these forward projections, so it actually might be another decline when it comes out, while earnings per share are boosted by Apple's share buyback program. Still, earnings per share has been flat over the last 12 months and with only about 5% earnings growth expected over the next year. So basically, you could say that just sort of abstracting from the exact numbers, you can say that Apple's growth has ended and it's just sort of flattened out in terms of both revenues and earnings.
Steve Davenport:
So if we would make the nature analogy, the Apple is sitting on the tree, but it's about to fall.
Clem Miller:
Well, that would be the concern.
Steve Davenport:
It's sort of wobbling up on that tree and a windy day, it could be all over, right, right, exactly what explains Apple's declining revenue? I see it everywhere. I see stores fall, I see the brand out there, but what's making the revenues decline?
Clem Miller:
So really the main thing is a lack of customer enthusiasm for the iPhone 15. And this has actually caused some concerns about whether the iPhone 16, which comes out this fall, will actually do any better than the iPhone 15 has. We have to keep in mind that a lot of the improvements to iPhones have been sort of very incremental and that we're talking about a product that costs a great deal of money and for individuals out there, you know it's a large purchase and so you know if they're gonna purchase a new one, they're going to wanna purchase it, purchase something that has a lot of new bells and whistles and very powerful new features. And a lot of folks, when they looked at the iPhone 15, I thought well, you know, maybe this is not the year to actually buy a new iPhone.
Steve Davenport:
You don't get excited about titanium cases. No, I mean, the thing I find is that, because the technology keeps changing, you wanna get a new one, but the ones that you have, I mean, they're gonna work much longer than you anticipate, and I've held most of my iPad and iPhones for much longer than I expected I would. So I think that they're almost creating part of their own. They want you to resume every three or four years, but they have a product that lasts five to six. So most people you know will, I think, make the economic decision to delay. What about the issues in the Chinese market? Can you talk about those?
Clem Miller:
So, yes, China's a big market for iPhones. However, apple faces some problems in China. Apple's big Chinese competitor, Huawei, just came out with advanced phones using new seven nanometer chips. Everybody was quite surprised that Huawei could produce seven nanometer chips, given the export controls the US and others have imposed on semiconductor equipment manufacturing and semiconductor design sales into China. Another factor that Apple is facing in China is that the Chinese government has decided to ban use of the phone by government employees, and you know this also is a. This comes out of national security concerns from the Chinese side that you know. Perhaps these phones include. You know, technology that would snoop on data. You know pretty much the same kind of concerns that the US has had about. You know Huawei telecom networking equipment and TikTok as well in terms of being able to collect data.
Steve Davenport:
Do you think it's just about that or do you think it has to do with what Apple has decided as regarding moving their production, when there were problems at the factories during COVID, and moving some of that manufacturing capability to India really seems like it was the slap in the face to the Chinese government, and could they be reacting to that?
Clem Miller:
Well, you know, I think you know, we're going to talk more about these decisions, about moving, but I would say that, in terms of a reaction by the Chinese government, I think it has a lot more to do with the things that I mentioned, which you know, which had to do with the government, employees and the market. You know the market demand declining on account of the competition from Huawei, I think you know. I think you know the Chinese government is not saying you know, apart from restricting government employee use, you know the Chinese government is not saying you can't sell here. So I don't think that it has anything to do yet with this. You know, idea that Apple might move, but you know, we'll see. Right, yeah, that's what makes.
Steve Davenport:
That's why we play the game. Yes, what about Apple other products in the App Store? Are they making up for some of the slowdown in phone?
Clem Miller:
Well, you know the iPhone constitutes such a large proportion of Apple sales. So you know the other hardware products in the App Store. They just don't make a huge difference when the iPhone isn't doing all that great.
Steve Davenport:
Do you think the investors are concerned about the Asian supply chain for Apple's chips and handsets?
Clem Miller:
Yes, of course they are. So Apple is reliant on chips made by Taiwan Semiconductor that's the world's largest semiconductor chip fabrication foundry. And of course, Taiwan is in China's crosshairs. In fact, they've been dropping hints, including to President Biden, out at the ASEAN summit in San Francisco or the APEC summit, I should say, out in San Francisco that they might invade sometime between 2025 and 2027. Who knows, right? Some people say Taiwan has a silicon shield that's the term a lot of folks are using in the foreign policy community A silicon shield against Chinese invasion? Maybe, I would say, but certainly that's not guaranteed, the idea behind the silicon shield being that China itself depends a lot on Taiwan semiconductor chips. So they don't want to cut off their nose despite their face, right, yeah?
Steve Davenport:
I mean, isn't Apple trying to develop their own chip? So there can be independent.
Clem Miller:
Yes, so they are trying to develop their own chip, but at the moment they're very dependent on Taiwan semiconductor. And see, with the CHIPS Act that was passed by the Biden administration, it'll help Apple. It'll help them re-shore chip supply, might help Apple develop their own chip, might help Taiwan semiconductor build facilities in the US They've already started to do that Will help Intel build some new chip capacity in the United States. But the thing we have to realize and this also goes to your point about changing production capacity from China to India is that reshoring and French shoring, which are the new buzzwords for this, are really long-term goals.
Clem Miller:
It takes many years to build semiconductor plants, so this doesn't happen overnight. I mean, semiconductor plants are some of the most sophisticated manufacturing facilities in the world. It requires a lot of clean water, for example. These facilities are very, very high-tech and it's not something that you can build overnight. And I do want to come back to another point that I want to make, even beyond just semiconductor chips, is that the mobile handsets that Apple uses are actually made in China itself by Foxconn, which is a subsidiary of a Taiwanese company called Hanhai Technologies. But Foxconn makes these handsets, and so Apple has a direct dependency on China with respect to these handsets, not just the dependency on the chips coming out of Taiwan semiconductor.
Steve Davenport:
Oh, that's part of the picture that I think people need to understand is there's a lot of interconnections. I guess, as an investor, I'm happy to see companies making longer-term and thinking longer-term. There's plenty of companies that think short-term and act short-term and you get frustrated, so I guess I'm glad about their effort. I think it's great that Apple is trying to re-shore or friend-shore, or just I like being at the shore. I just went to a wedding at the beach. So I guess another potential issue would be the EU-European Union competition policy. What can you say about that?
Clem Miller:
So the EU is getting more aggressive on dealing with US mega cap tech companies. In fact, they just put out something called the Digital Markets Act, which squarely aims at Google and Microsoft and Apple and Amazon and Meta all the magnificent seven minus, obviously, Tesla. But they're getting more aggressive. You might have noticed that Apple had to move from its proprietary lightning cable to the USBC cable as part of its iPhone 15. And guess who caused that to happen? The EU. It was an EU standard, and the USBC is an EU standard product. So this was a way of the EU sort of getting involved in market decisions involving US companies. So that's a EU standard setting actually has a name attached to it. It's called the Brussels effect, where essentially the EU makes standards for the whole world. That's the idea anyway. They've taken the standards that they impose throughout the European Union and they require anybody doing business in the EU to use it also worldwide, and so that's how Apple was required to actually do that.
Steve Davenport:
That doesn't sound very open.
Clem Miller:
And who knows, they might make changes to the app store as well, Steve.
Steve Davenport:
Well, Clem, let's consider your valuation point. You consider Apple to be overvalued. We use Morningstar. Morningstar has a price target of $160 and so it's rated at two and it's overvalued. Can you put some metrics on what your valuation point is?
Clem Miller:
Well, I'm looking. I don't set, in my own analysis, a particular price target. I'm not sure that price targets are terribly reliable, to be honest with you, even from a prestigious organization like Morningstar. I would say, though, that I look at their trailing PE and their forward PE, and I see a trailing PE of around 30 times and a forward PE of around 28 times. I see that those PE's were a lot lower at the beginning of 2023, before a share price surge, and I just think, based on those and the fact that revenues are flat or declining, earnings are flat or declining, I just see Apple as being quite overvalued. Granted Apple, you don't see PE's in the 50, 60, 70 times range, but those might be justified for companies that are growing at 20, 25, 30% a year. Apple's not growing at all, and so 28 and 30 look expensive.
Steve Davenport:
But what are some of the positive things we could say about Apple?
Clem Miller:
These are really the reasons why I still have it at all in my portfolio. It has strong profitability a 25% net profit margin. It has large positive free cash flow 21% free cash flow margin. It has a low short interest ratio 0.77% so there aren't a lot of short sellers trying to sell it forward and also the company's Glassdoor rating. Glassdoor surveys employees about how they feel about their companies. The Glassdoor rating suggests that Apple employees are very highly satisfied. So, yeah, those are very good things and a reason to hold it. It's just the uncertainty about revenues and the high valuation which concerns me.
Steve Davenport:
Clem, I guess on balance you find that there are equal or better opportunities available for allocations in the portfolio. What do you think those would be?
Clem Miller:
Well, obviously I have a number of stocks in my portfolio, including others in the Magnificent 7. I hold right now among the Magnificent 7 companies I hold not in addition to Apple, where I'm significantly underweight, I also hold Amazon. I hold Google, I hold, that is, Alphabet I should say Amazon, Alphabet, Meta and Microsoft. I hold those in weights that are less than S&P market weights but much larger amounts than I would hold Apple in. So, yes, those are the better opportunities, but I think conceptually, one should always question whether the company with the largest market cap weight in the S&P 500 can really maintain that position. If history is any guide, I think we will see the rankings evolve and Apple will fall out of that top spot, and what we really want to be in are the stocks that can replace Apple in that top spot down the road. Good, advice.
Steve Davenport:
I think we'll look at the mailbag and the only question, the question that's in there is do we own Apple? You've answered your question. We currently don't. We like Google, we like Microsoft, we don't like Tesla, we don't like Meta or Facebook. And let's say what other we do, like Nvidia. So in some ways it comes down to, like you said, the growth rate. You're paying for the PE, you're paying for the growth rate and we like the PEG and we use that in our analysis. Do you want to sum it up for Apple, Clem?
Clem Miller:
Well, I would just say, going over the key points that we've talked about today, first of all, apple is definitely a stock you can't ignore, being the highest weighted stock in the S&P 500. It's a stock where there are serious concerns about whether it can maintain revenue growth and earnings growth. There are issues with regard to Apple's interplay with China, both in terms of demand and potential geopolitical risks now and down the road. There are issues surrounding where chip supply that arise from those geopolitical risks and how long it might take Apple to develop sourcing from outside the region. Eu competition policy plays a role with respect to potential Apple ability to do business in the EU. The app store, I would say, might be something that the EU might take a look at.
Clem Miller:
And I think probably the most important thing in addition to the revenue concerns is the fact that it's gotten more expensive. I mean, they had had a nice run in 2023 and then up through the early fall and then since then, valuations have gotten more and more expensive as revenue has tailed off. Yeah, I don't like those valuations, but I find enough in the high profitability, the high free cash flow, the low short interest ratio and employee satisfaction to keep my foot in the door of Apple, but at far less than the full market rate. So that would be my summary, thanks.
Steve Davenport:
I appreciate all the analysis and I think you did a great job. Looking soon on our list, we're going to have a podcast about the top five personal finance tips for people getting started with their investments. Again, happy new year and we look forward to delivering results and podcasts that you enjoy. Thanks again.