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December 01, 2005

Trimming, Rather Paring, Apple Again :-)

On Monday, I trimmed client positions in Apple Computer (AAPL). The reasoning was similar to the decision to sell in September when the stock first crossed $48: maintain discipline and take some money off the table when a stock reaches an established target price. At the time of the September sale, I decided my next target would be in the low to mid-$60s. I was thinking that 2005 would end strongly for the company but like everyone else on the planet except Steve Jobs I did not expect the iPod nano introduction. Estimates have risen since the nano was introduced but at the time I was thinking the company could make around $1.70 in FY06 ending next September (consensus was only $1.62) . Cash was about $9 per share producing 15 to 20 cents of the earnings. Thus, to reach the mid $60s, the stock would need to trade at 35-40 times current years earnings adjusted for interest income plus the $9 in cash. In a growth starved world, that seemed like a reach but possible. As a comparison, today's most popular growth stock, Google (GOOG), trades at 47 times the current 2006 consensus earnings estimate....

Since the introduction of the nano, the consensus estimate for AAPL in FY06 has risen to $1.79 with a high estimate of $1.95. Use the same math and the extra 10 cents in EPS adds $3.50 to $4.00 to the target price. Thus, beginning early last week, I decided to lighten again if the stock crossed $68. Lucky for me, my initial open order was not filled and I left for the Thanksgiving holiday. I spent Friday sitting in a Panera Bread (PNRA) in Northern Kentucky using the free high speed wireless service. The stock was up a lot and nearing $70 but I made an educated guess that analysts would be positive on the company's initial holiday sales and decided to wait until Monday morning to lighten. Due more to good luck than good analysis, on Monday morning I sold down client positions to a 2% holding just short of $71.

To justify a target above this price requires either significantly higher FY06 estimates or a look out to FY07. Current consensus for FY07 is $2.10 with a high estimate of $2.30. Use the same 35-40 multiple and add back what will then be over $10 in cash and a target close to $90 can be established. For now, I've decided that is my next target to trim the position or exit completely.

Another reason I wanted to trim the position is that I am getting a little worried that expectations for AAPL are getting out of hand. This sets up a dangerous short-term reaction to the next earnings report similar to what happened in October when AAPL initially sold off sharply when it reported quarterly earnings. At the time, I thought that the selling was an overreaction. Now the stock is up another 50% and almost everyone has raised iPod shipment forecasts and earnings estimates.

On the flip side, AAPL is still gaining market share in PCs and rumors of an early introduction of the Intel-based Mac are gaining credence. This might allow calendar 2006 to be the year the halo effect finally takes over from iPods in driving AAPL's share price and fundamentals. Nevertheless, the risks are up relative to the reward so a more cautious approach is warranted.

One thing I have learned during my 24 year investment career is that if you ring the register occasionally on winning positions, you can take the risk of riding momentum. The prior sale of AAPL and similarly reasoned trimming of Motorola (MOT) and Sears Holdings (SHLD) earlier this year, are all examples of ringing the register. While AAPL and MOT have continued to work significantly higher, SHLD has dropped sharply since it was trimmed. However, because it was trimmed the pain of the decline has been lessened and the overall return on the original position has held quite high.

Posted by Steve Birenberg at December 1, 2005 10:02 AM in AAPL