What I Really Think About Investing in Apple

Contrary Thinking on Buying Insurance

What I Really Think About Investing in Apple

One Great Stock

In response to my Monday travelogue on driving through Austria and Slovenia to Venice, a reader from McAllen, Texas, wrote the following.

“I have been a long time subscriber of the various Cabot wealth letters and have always enjoyed and profited from them. I have especially enjoyed reading your ‘non-investment’ comments, like today’s about your travels and vacations.
“Which brings me to my question. I am traveling to Spain for my 60th birthday leaving on the 24th of April and returning on the 20th of May. My wife and I will be renting a car with Hertz, we will probably log 2,000 to 3,000 km. In the states I have always declined the insurance offered by the rental agency and relied on the benefit of insurance coverage offered by my credit card. Fortunately I have never had to submit a claim for damages in the states. My question to you is what do you recommend as far as additional coverage and accepting the separate coverage by buying additional insurance. What have you done in your travels overseas when renting a car?”

My Answer:

“Many years ago I wrote a column on insurance, and I may repeat it someday. The core idea came from my father, whose first job out of college (he was a mechanical engineer) was doing inspections for an insurance company.

“In brief, it is this. Only buy insurance when the lack of it might lead to unbearable financial distress. If you decline insurance often enough, you’ll come out ahead in the long run, just as if you buy insurance often enough, the insurance companies will come out ahead in the long run … that’s why they’re so rich.

“As to insurance on rental cars, in the U.S. the credit card generally covers it, and in Europe, the credit card may not. Nevertheless, I decline as much insurance as possible whenever I rent a car. On this latest trip, my car rental cost as a result was $845 (including substantial taxes) instead of $1206.

“Also, I have found it useful to carry a black Sharpie marker to hide the occasional scratch. If you do this, you may even go so far as to request a black car!”

Moving on, another reader asked, “Is Apple a good buy at this level?”

No doubt that’s a question thousands of investors ask every day.

And the curious thing is this … I have two answers.

The simplest comes when I put on my hat as Cabot’s publisher. I look to see if any of our publications have recently recommended Apple (AAPL) and I find that one has–Cabot Benjamin Graham Value Letter.

The editor of the publication, Roy Ward, has a very objective–and extremely data-intensive–method of calculating the fair value of individual stocks. His system relies on buying well-managed companies at a significant discount to this value, and holding patiently until the price is overvalued to the point where risk is too great. (You can read more about the system here.)

Apple is indeed listed in Roy’s table of “Top 250 Value Stocks,” where you can find many well-managed companies. Today, Roy says Apple’s Maximum Buy Price is 570. If you buy above that level, you lose the important Margin of Safety.

And Roy calculates Apple’s Minimum Sell Price as 978. Some investors might call that a target price, but Roy would recommend sticking with the stock as long as it kept climbing beyond that level, while using a well-positioned stop to minimize any major loss of profits.

As I said the system is simple, and it’s objective. But that doesn’t mean an investment in AAPL is a slam-dunk sure thing. To use the Cabot Benjamin Graham Value Letter investing system properly, it’s best to own a well-diversified stable of stocks bought using the same system–at least 10 stocks for small accounts, more for larger accounts–so that the winners outweigh the occasional loser.

The more complex answer about investing in Apple comes when I put on my growth investor hat. That’s the hat my father taught me to wear, and the one that fits most comfortably on my head.

I start by looking at the chart, noting that the stock’s long- and short-term trends are both up. That’s good. Furthermore, the recent pullback of nearly 10%–to almost touch the 50-day moving average–makes this chart rather attractive.

Next I look at the numbers to make sure this is a true growth company. There’s no problem there; everyone knows Apple has a great track record of growth.

Looking forward, it’s clear more great growth is likely as well. People will continue to upgrade their computers and iPhones and iPads and Apple products will continue to spread around the world. Before long, an Apple TV is likely.

Now, I don’t typically look at valuation when analyzing growth stocks, but I can’t ignore the fact that the stock is undervalued according to Ben Graham’s system … so that’s a plus.

And, peripherally, the facts that Apple has no debt, has roughly $100 billion in cash and recently instituted a dividend that pays 1.7% per year are further positives.

As to management, all indications are that AAPL has a great team. Yes, Steve Jobs is gone, and in his absence the company may eventually lose its way, or compromise by putting out less-than-perfect products, but so far all appears well.

The one quantifiable negative I can see is that AAPL is owned by more than 1,000 mutual funds. Also in the same category is the fact that Apple is the most richly valued company in the world, that the stock is the largest component of the major stock indexes and that it’s the largest holding of numerous institutional investors.

And what’s wrong with that?

Well, these institutions own Apple because doing so helps them match the performance of the indexes, because not owning AAPL would bring critical questions from their shareholders/trustees and because it’s a very liquid investment.

But eventually the stock’s popularity will backfire. Eventually, a time will come when all possible owners own AAPL, when there are no potential buyers left … and that’s when the sellers will take control.

I saw it happen with IBM. I saw it happen with Microsoft, and I have no doubt that I will see it happen with Apple. I simply don’t know when.

But I’m fairly confident that the stock’s long, profitable uptrend is closer to its end than its beginning.

But what if the stock keeps going up and you don’t own it? Does that make you (and me) wrong?

No, not any more than the fact you don’t own CREE, which was up 43.5% in the first quarter.

The point is you don’t need to own AAPL to be a successful investor. In fact, as a growth investor, I think there are better risk/reward relationships to be found among numerous less popular stocks … and I’ll recommend one below.

The high-potential stock I’m spotlighting today, which is far less popular than Apple, and thus has much more room to grow, is Sourcefire (FIRE).

The company is a leading provider of network security software and services, setting up firewalls, dealing with malware and in general creating safe and secure computing environments. What I like about it, aside from its positive chart, are two recent trends in its numbers.

First is the trend to accelerating growth of revenues; they were up 19%, 25% and 40% in the latest three quarters.

Second is the trend to fatter after-tax profit margins; they were 6.5%, 12.6% and 14.2% in the last three quarters.

As a result, the first quarter of this year saw earnings surge 47% to $0.25 per share.

The stock was recommended earlier this month in Cabot Top Ten Trader. After reviewing the business, editor Mike Cintolo wrote this about FIRE’s chart:

“FIRE wasn’t a leader during 2010 or 2011, as the stock traded in a wide 20-to-30-range for months. But that changed in February, when the stock staged a giant earnings gap higher to 46 (volume was nearly 10 times average!) following a blowout earnings report. Since then, shares have crawled higher, testing their 25-day moving average last week. FIRE is volatile and somewhat thinly traded (about $30 million per day), but its recent decline is setting up a decent opportunity. You could buy some down a point or two.”

The stock was trading at 48 then and, sure enough, subscribers who waited had an opportunity a few days later to snag it under 46. But now it’s topped 50. What to do now?

You could just rush in and buy here, but it would probably be wiser to take a look at the latest issue of Cabot Top Ten Trader, to read Mike’s latest advice on the stock … as well as to learn about similar high-potential stocks.

Yours in pursuit of wisdom and wealth,

Timothy Lutts
Cabot Wealth Advisory

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