Is AAPL bruised or beginning to rot?

There’s a huge difference between Apple the company and AAPL the stock.  Back in July when the stock seemed to headed to the stratosphere I began to get concerned.  At the risk of seeming ridiculous (which has never stopped me before fyi) I will quote myself at the time:

 “The market value of Apple Inc. has ballooned.  It really hasn’t mattered that Android devices are kicking butt; rapidly gaining market share and being adopted by the more technology-savvy consumers (the nerdy trailblazers).  Until now?” July 29th, 2012

Apple’s 2nd quarter results had just been released and were considered disappointing by most analysts.  However my misgivings were based more on experience than the company fundamentals.  Over decades I’ve watched stock market darlings follow a pattern time and again.  At the outset it’s product itself that folks fall in love with, but eventually it’s the company’s stock they become infatuated with.

Admittedly the rewards to the company are plentiful if the product catches fire, especially in the middle stages of the lifecycle (pricing power and growing demand), but gradually management is obliged to focus on producing more and more of the product; which can mean skyrocketing revenues and economies of scale (reduced costs of manufacturing) – good for the company and its investors.  Eventually competition rears its ugly head, and the company is forced to innovate rapidly (rising expenses) to keep market share.  Competition (Android devices offered by the likes of Samsung, Research in Motion) will inevitably cause prices and profit margins to fall.

Finding a new hit ‘premium-priced’ product is difficult to do unless the company is managed by a tyrannical genius like Henry Ford or Steve Jobs (who can be oblivious to the rantings of those myopic stakeholders who’d rather have dividends than invest in research and development).

One might think that the stockprice should mirror the fortunes of the company.  But there are periods when this just isn’t the case.  This is the chart I was looking at (back in the summer months) when I began to get the heebeejeebies.  The financial results weren’t that impressive, but the share price had gathered its own momentum.

A GOOD  THING: Lineups to buy iPhones and iPads.  DANGEROUS: Lineups to buy shares.

I like to think the stock market  is like a party.  When my daughter was a teenager, she asked if my wife and I could disappear for a few hours one evening so she could invite some friends over for a party (I’m sure this has happened to many of you).  Things went fine until a contingent of uninvited guests began showing up.  No doubt a few more youngsters added to the fun, but once the house was too crowded bad things began to happen – items got broken, drinks were spilled on hardwood floors and carpets, there were empty bottles scattered all over the property and suddently her little party turned into into a nightmare.

When uninvited people (not really investors) scramble to own a stock it usually ends up like my daughter’s party.  At first a few more (uninvited) investors drives up the price which is great for existing shareholders and the company.  Indeed, AAPL shares continued to ramp up into the final quarter of 2012.  But just like my daughters party, things began to get ugly for the stock once it got too crowded.

 There is much speculation concerning the causes of the rapid decline in the price of AAPL shares:  Weak demand for the iPhone V, the threat of Android market penetration and so forth.  Some of this might be true, but pure speculation doesn’t ordinarily impact the price of a company’s shares this radically.  Hard evidence will hurt the stock to be sure but my own experience is that as soon as people realize they’re at a party that just isn’t as much fun as they’d hoped for then they all try to leave at the same time.  There is a great deal of risk associated with buying into stock market darlings.

I mentioned above that there can be a huge difference between the fortunes of the company and the behavior of the stock.  It could very well turn out that Apple (the company) will continue to thrive despite the decline in the share price.  After all there are a great number of people that still plan to buy iPhones.  No doubt there are also many planning to buy other Apple devices.

A recent survey suggested that 50% of those asked what smartphone they intend to buy over the next ninety days said they wanted an iPhone.  This is the same result Apple has enjoyed for that past couple of years.  There will come a time when the company will have to come up with another big hit product or re-invent itself.  After all the company was nearly banktrupt once (1987) and survived.  The introduction of the iPhone in 2007 certainly gave Apple another shot of adrenalin.

There’s no evidence to suggest Apple the company is beginning to rot just yet, but AAPL the stock was due to take a bruising.  Can Apple continue to take advantage of its solid franchise indefinitely without Steve Jobs?  Well that’s the billion dollar question isn’t it?

Mal Spooner

 

 

Banks own the investment industry! A good thing?

Let’s face it!  In the battle for investment dollars the Canadian banks are clearly the winners!  Is this a good thing?

Once upon a time, the investment business was more of a cottage industry.  Portfolio manager and investment broker were ‘professions’ rather than jobs.  Smaller independent firms specialized in looking after their clients’ savings.  There were no investment ‘products.’  The landscape began to change dramatically – in 1988 RBC bought Dominion Securities, CIBC bought Wood Gundy and so on – when the banks decided to diversify away from lending and began their move into investment banking, wealth management and mutual funds.

Take mutual funds for example.  Over the past few decades Canadian banks have continued to grow their share of total mutual fund sales* – this should not surprising since by acquisition and organic growth in their wealth management divisions they now own the lion’s share of the distribution networks (bank branches, brokerage firms, online trading).

An added strategic advantage most recently has been the capability of the banks to successfully market fixed income funds since the financial crisis. Risk averse investors want to preserve their capital and have embraced bond and money market funds as well as balanced funds while eschewing equity funds altogether. With waning fund flows into stock markets, how can equity valuations rise?  It’s a self-fulfilling prophecy.

Many of the independent fund companies, born decades ago during times when bonds performed badly (inflation, rising interest rates) and stocks were the flavor of the day, continue to focus on their superior equity management expertise.  Unfortunately for the past few years they are marketing that capability to a disinterested investing public.

The loss in market share* of the independent fund companies to the banks continues unabated. Regulatory trends also make it increasingly difficult for the independent fund companies to compete.  Distribution networks nowadays (brokers, financial planners) require a huge and costly infrastructure to meet compliance rules.  Perhaps I’m oversimplifying, but once a financial institution has invested huge money in such a platform does it make sense to then encourage its investment advisers and planners to use third party funds?  Not really! Why not insist either explicitly (approved lists) or implicitly (higher commissions or other incentives) that the bank’s own funds be used?

Stricter compliance has made it extremely difficult for investment advisers to do what they used to do, i.e. pick individual stocks and bonds.  In Canada, regulators have made putting clients into mutual funds more of a burden in recent years.

To a significant degree, mutual fund regulations have contributed to the rapid growth of ETF’s (Exchange-Traded Funds).    An adviser will be confronted by a mountain of paperwork if he recommends a stock – suitability, risk, know-your-client rules) or even a mutual fund.  An ETF is less risky than a stock, and can be purchased and sold more readily in client accounts by trading them in the stock markets.  Independent fund companies that introduced the first ETF’s did well enough for a time but not surprisingly the banks are quickly responding by introducing their own exchange-traded funds.  For example:

TORONTO, ONTARIO–(Marketwire – Nov. 20, 2012) – BMO Asset Management Inc. (BMO AM) today introduced four new funds to its Exchange Traded Fund (ETF)* product suite.

In fact, the new ETF’s launched by Bank of Montreal grew 48.3% in 2011.  When it comes to the investment fund industry, go big or go home!  You’d think that Claymore Investment’s ETF’s would have it made with over $6 Billion in assets under management (AUM) but alas the company was recently bought by Blackrock, the largest money manager in the world with $29 Billion under management.  It will be interesting to see if the likes of Blackrock will have staying power in Canada against the banks.  After all RBC has total bank assets twenty-five times that figure.  Survival in the business of investment funds, and perhaps wealth management in general depends on the beneficence of the Big Five.

Admittedly, the foray of insurance companies  into the investment industry has been aggressive and successful for the most part.  With distribution capability and scale they certainly can compete, but the banks have a huge head start.  Most insurance companies are only beginning to build out their wealth management divisions.  I can see a logical fit between insurance and investments from a financial planning perspective, but then the banks know this and have already begun to encroach on the insurance side of the equation.  Nevertheless I would not discount the ability of the insurance companies to capture signficant market share.

So, is it a good thing that larger financial institutions own the investment industry?  Consider the world of medicine.  No doubt a seasoned general practitioner will feel nostalgic for days gone by when patients viewed them as experts and trusted their every judgement.  The owner of the corner hardware store no doubt holds fond memories of those days before the coming of Home Depot.  Part of me wants to believe that investors were better served before the banks stampeded into the industry but I’d just be fooling myself.  Although consolidation has resulted in fewer but more powerful industry leaders, the truth is that never before have investors had so wide an array of choices.  Hospitals today are filled with medical specialists, while banks and insurance companies too are bursting at the seams with financial specialists.

It is not fun becoming a dinosaur, but this general practitioner has to admit progress is unstoppable.

Malvin Spooner

 

 

 

 

 

 

 

 

*The industry charts are courtesy of the third quarter Scotiabank research report Mutual Fund Review.  The annotations are my own.