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Q: I am interested on your thoughts on investing in Apple stock (AAPL). I suspect that some of the glitches in the new iPhone 4 created a buying opportunity. And when Apple opens the iPhone to carriers other than AT&T, they could double or triple their sales. After participating in the frenzy to purchase the new iPad, I expect their customer loyalty remain strong.
Stop Coveting My iPad
Dear Stop Coveting,
Your question reveals that you are more interested in speculation than you are in investing.
Apple stock has risen almost 100 percent in the past year, and attempting to time the purchase of a hot stock with strong momentum is a game played by speculators. John Maynard Keynes wrote that speculation is “the activity of forecasting the psychology of the markets.” If speculators are psychologists, Mr. Market is bipolar. At times, highs bounce to lows within a day. At other times, a long-lasting euphoria breaks without notice. Forecasting these psychological and emotional shifts is a rewarding practice for only a small percentage of the most highly trained professionals.
Some mathematicians argue that training has little to do with a speculator’s success. Have 100 people roll a pair of dice two times, and you are likely to have three of them roll pairs on both.
Wall Street loves speculators because they often get out of a stock just as quickly as they got in. And every time a trade is made, a coin drops into a Wall Street coffer. Studies by John Bogle, founder of Vanguard, show a direct correlation between turnover and performance. The more often you trade, the less likely you are to achieve a market return.
Your assumption that Apple sales will grow rapidly is likely true. What you fail to realize is that rocket ship growth is already factored into the projections of stock analysts and is no guarantee of an adequate return on your money. Hundreds of professionals estimate the future sales and earnings prospects of publicly traded companies every day. As I write, Apple stock is trading at a price-to-earnings (P/E) ratio of 20, which means an investor is paying $20 for every dollar of reported earnings.
This compares with an average P/E ratio of 15 for the S&P 500 companies. Focusing on valuations, stock market participants are paying 33 percent more for Apple and betting that Apple’s growth will pay for this premium. Apple might be able to pull this off, but the odds are not in their favor. Studies show that stocks trading at lower P/E multiples, on average, will outperform those trading at high multiples. Speculators see a quick profit but often do not realize that they are paying a healthy premium for the ride.
Alternatively, investors apply thorough analysis and historically validated disciplines when they allocate capital. Prices go up and down, but at the end of the day investors’ return on capital will be based on business earnings. When investors make a capital allocation, they are not simply investing in the price momentum of a stock. They are becoming co-owners in a business and entrusting corporate stewards with their capital. This is how Warren Buffet views his investments, and many would do well to adopt his philosophy.
There is nothing wrong with wanting to speculate on Apple stock. It can be fun to share the financial outcomes of a company you admire (when the stock price is rising). However, I recommend that you limit your speculation money to less than 10 percent of your investment portfolio and keep this money separate from your investment assets.
“Wall Street loves speculators because they often get out of a stock just as quickly as they got in. And every time a trade is made, a coin drops into a Wall Street coffer.”
If the United States was smart, it would listen to citizens like Ralph Nader, who have suggested a penny tax on all securities trades as a way to get rid of the national debt. Taxing speculation makes sense and would actually make our capitalist economy more efficient.
I can appreciate the good intent of the author warning us of the dangers of speculation but you could probably be much tougher on Apple here. Apple is about to be on the losing end of a major paradigm shift in the smartphone sector. There is no way a closed off vertically integrated company like Apple will be able to compete with the open nature of the Android OS and/or hardware. Google is giving it away for free and already turning a profit due to the increased search revenue it generates. Add that to the fact that you have 5-10… Read more »
@ – Kevin Anderson I agree with the upcoming paradigm shift in the smart phone industry that you mention and would like to add to it. Apple, over the years, has enjoyed a exclusivity of being a “cut above the rest” when it comes to their hardware and operating systems. This is mainly due to Jobs & Co. treating their products as works of art and keeping everything Apple…well…Apple. My MacBook Pro looks just as great closed up on my desk as it does open and my iPod Touch, which I’m happily listening to right now, is an elegant piece… Read more »