Why is it that some of the most influential CEOs and Fund Managers only predict “exponential returns” and bright futures for some of the market’s most expensive stocks?

Can they only find the future in stocks where there is overwhelming consensus and exorbitant valuations?

This piece uses an example of the market’s most vaunted winner, Apple Computer, to:

  • make the point that forecasting outsized winners ex-ante is nearly impossible
  • review KCR’s historical track record on Apple stock
  • explain what our models are saying about Apple today

A Complete Stock Market Trading and Forecasting Course in One Picture & Post

The Apple II An Uncertain Path to iPods iPhones and the Apple Ecosystem of Immense Profits

The picture above is of the Apple II. Launched in 1977, the Apple II was a big part of what vaunted the company to fame. That same PC still made up nearly 10% of Apple’s sales in 1989. To have truly cashed in on Apple’s long-term share price, you had to know that thing would become today’s ecosystem of iPhone users.

Is Apple a Good Stock to Own?

  • The chart shows that buying Apple in 1989 would have turned $1 into $700 today
  • That would have been a terrific decision – buy and hold
  • KCR has precisely zero idea who the next big hit like Apple will be and doubts anyone else does either

Hindsight is the Greatest Investor KCR has Ever Seen AAPL

With hindsight seeing what the company would become was easy. In 1984, Apple made that incredible Super Bowl Advertisement playing off George Orwell’s dystopian novel “1984.” They literally told you they were going to be the next big disruptor.

You just had to avoid investing in Packard Bell, Gateway, Compaq, Leading Edge, Magnavox, NCR, or the endless other ill-fated and kinda melty PC makers that went under[1] or were pushed to the sidelines. There was also that bit where Steve Jobs recruited the CEO of Pepsi, John Sculley, to run Apple, and the two had a huge falling out.

Steve Jobs then started NeXT computer and was out to kill Apple.[2] Then, of course, Apple’s sales collapsed, profits plunged 84%, and their software fell badly behind Windows OS. Business Insider’s Clancy Morgan posted this phenomenal five minute video that offers younger readers a quick summary of the tumult.

In 1989 the New York Times’ article Apple Strays from Mass Appeal noted high prices and weak demand had sent sales into a tailspin. Further complicating matters, Apple missed revenues and earnings which, when combined with “…jitters over high-technology stocks in general…” sent the stock plunging 20%.”

The chart below shows the price to sales ratio of Apple since 1989. In 1989 Apple traded at only 1.5x sales despite sporting a 40% return on equity and a 5% total yield. Apple’s path to the iPhone 13 and booming cash flows began as a lowly value stock beset by the uncertainty which defines tech investing.

AAPLs Ascent to Greatness Began as a Value Stock

Apple’s status as a dominant force in consumer electronics and software was anything but clear. Investing with hindsight is easy. Seeing the future less so.

We recently wrote a quick piece that offered a dim view of those who are making grandiose promises of finding the next big winner in the stock market. In our July post last year, we transcribed part of a video presentation (which you can also watch there) of Peter Lynch, where he explained how investors get crushed chasing complex tech stocks while ignoring durable, proven, and profitable firms. For those looking for mispriced growth, please see our research on our GARP stock screener.

Is it a Good Time to Sell Apple Stock? Maybe….

If you hadn’t noticed, KCR is not in the forecasting business. We are most emphatically in the investing business. There is a difference.

The chart below shows the exact same chart as the SECOND chart on this post. The only difference is we made the axis a log-scale, which helps you see the changes in returns much more easily.

Wherever the chart is shaded green, KCR was bullish. White areas are where we are neutral. Red shading indicates we were bearish.

Please see our explanation of our ranking tools to better understand our methodology.

Our models were there at the beginning. Alas, they failed to just hold on. The most notable absence being between 2003 – 2014. That’s 11 years of having….no view.

KCR Missed a Great Deal of the Run but Still Managed to Capture a 1000% Return

Over the whole period, the stock rose a staggering 5,646%. We missed out on a lot. We are neutral today.

Why would we show you this?

  • we strive to be honest
  • to help explain how our stock ranking tools work
  • to show that one need not foresee the future to make a great deal of money

The beauty of combining dispassionate quantitative models based on behavioral finance with fundamental oversight is that they kick our egos right out of the room. We are not allowed to regret missing out on past returns.

By 2014 the fundamentals had begun to catch up with the stock price. Despite missing a massive run, the models forced us to re-evaluate Apple. Think it through and assess “at this price and with the business having evolved, is this a good investment?”

We readily admit KCR’s model missed a large chunk of return in that “neutral zone.” But we have held an unambiguously bullish stance for the last 1,000% return. We are comfortable with such outcomes.

Our ranking tools are designed to invest when there is some margin of safety in a stock unlike what we see in cleantech stocks. Over a big chunk of that period above, Apple’s stock was expensive. Expensive amplifies risk.

The odds that Apple can mimic the last decade of returns over the next 10 years seems unlikely to us. Our model will tell you that Apple is a great company. The model will also tell you that, unlike in 1989, everyone agrees it is a great company today; an effect captured in the firm’s elevated valuation.

Common sense indicates it could be tough for a tech giant with a $3 trillion market cap valued at nearly 10x sales to compound at above-average rates for a long time. We have no idea who the next Apple or the next Amazon will be. But our piece next Wednesday will highlight the immense opportunity we see for those interested in finding growth stocks at reasonable prices, many of which look an awful lot like AAPL circa 1989.

As always, we encourage investors to seek individualized investment advice. Study financial history if possible. Learn from the greats and ignore the hyperbole.

  1. As a reminder for our Financial Advisors: our models are available on a continuous basis, and most have been in production for over a decade.  If you are looking for simple, concentrated, low turnover, and tax efficient model portfolios we would like to talk with you.  KCR also offers a wide range of easy-to-use but sophisticated tools.  Our toolkits can help identify mispriced stocks with the best and worst risk/reward characteristics, estimate a stock’s duration and warn you when a company is engaging in low-quality accounting. Over the last 12 years, KCR has built and offers time-tested and class-leading products built by experienced and proven money managers for fixed to low prices.
  2. Kailash Capital’s sister company, L2 Asset Management, runs market neutral, long/short, large-cap, and mid-cap long-only portfolios with a value and quality bias.  L2 employs a highly disciplined investment process characterized by moderate concentration, low turnover, high tax efficiency, and low fees. While nobody can predict the future, we believe the recent resurgence in risk-adjusted returns seen across all products is the beginning of what may be a long period where speculation is punished, and prudence and patience rewarded.
The topics discussed in this article are aimed at seasoned professionals, as such, we have included some extra for anyone seeking out more information related to the topics above.

[1] Pretty wild right?  Whole Wikipedia page and an entire universe of web-culture dedicated to once glamorous tech companies that are bankrupt or down and out.

[2] The Montreal Gazette, August 13, 1989, Steve Jobs: Biting back at Apple Ousted from giant he helped found computer legend is out for revenge, Phil Patton, New York Times Magazine

Disclaimer

The information, data, analyses, and opinions presented herein (a) do not constitute investment advice, (b) are provided solely for informational purposes and therefore are not, individually or collectively, an offer to buy or sell a security, (c) are not warranted to be correct, complete or accurate, and (d) are subject to change without notice. Kailash Capital, LLC and its affiliates (collectively, “Kailash Capital”) shall not be responsible for any trading decisions, damages or other losses resulting from, or related to, the information, data, analyses or opinions or their use. The information herein may not be reproduced or retransmitted in any manner without the prior written consent of Kailash Capital. In preparing the information, data, analyses, and opinions presented herein, Kailash Capital has obtained data, statistics, and information from sources it believes to be reliable. Kailash Capital, however, does not perform an audit or seeks independent verification of any of the data, statistics, and information it receives. Kailash Capital and its affiliates do not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only and is not intended to provide, and should not be relied on for tax, legal, or accounting advice. You should consult your tax, legal, and accounting advisors before engaging in any transaction. © 2021 Kailash Capital, LLC – All rights reserved.

Nothing herein shall limit or restrict the right of affiliates of Kailash Capital, LLC to perform investment management or advisory services for any other persons or entities. Furthermore, nothing herein shall limit or restrict affiliates of Kailash Capital, LLC from buying, selling or trading securities or other investments for their own accounts or for the accounts of their clients. Affiliates of Kailash Capital, LLC may at any time have, acquire, increase, decrease or dispose of the securities or other investments referenced in this publication. Kailash Capital, LLC shall have no obligation to recommend securities or investments in this publication as result of its affiliates’ investment activities for their own accounts or for the accounts of their clients.

January 21, 2022 |

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