Rotten Fruit?

Has Apple’s shine come off?

Shares of Apple tumbled after their earnings release. While they met sales and earnings expectations, their margins narrowed, and they didn’t so much trim their guidance on future earnings so much as “shade” it—telling analysts that management’s expectations for future earnings were realistic rather than conservative: code for “We’ll beat this, but not by a lot.”

It was the profit margin that had investors worried, though. Their gross margin declined to 39% from 45% a year ago. The concern is that as Apple moves to lower-priced items in its product list, there just isn’t as much room for their fat margins. So in spite of 40% annual sales growth and 60% annual earnings growth over the past 5 years, the stock is now valued at 7.5 times earnings, adjusting for Apple’s massive cash hoard—35% below its high price last September.

Up until now, Apple could do no wrong. It was one of the four major asset classes: stocks, bonds, cash, and Apple. It grew to over 3% of the entire US market, and its soaring performance has been a big reason why so many portfolios have trailed their bogies—any decision other than to buy Apple has subtracted value.

The company and its shares have been a victim of their own success—growing to the point where the law of large numbers makes exponential growth increasingly hard. But even if the company moves to a more modest growth track, the stock is exceptionally cheap—valued more like a slow-growing utility than a world-changing technology innovator.

The recent swoon in the share price reminds everyone that trees don’t grow straight to heaven and don’t put all your eggs in one basket. Rational portfolio management demands diversification, no matter how hot one company’s prospects may be.

Douglas R. Tengdin, CFA

Chief Investment Officer

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