Market-Beating Pros Buying New Value Stock
When Apple (AAPL) reports its quarterly earnings this week it will be aiming for painfully lowered targets. During the quarter estimates fell 21% according to Factset, pretty much dragging down the entire info tech sector along with it. At the start of the quarter, earnings estimates for S&P 500 tech stocks was a soft -0.4%; by quarter end the sector’s expected earnings forecast was -6.5%.
And there’s nothing to suggest Apple will be regaining its mojo anytime soon. Yes, CEO Tim Cook has promised exciting new products starting in the 4th quarter. But as Fortune writer Adam Lashinsky devastatingly laid out in a recent article, any iWatch or iTV won’t be innovative, but iterative, as others -- Google (GOOG) for example -- are already out in the market with product or working on their own launches.
As Lashinsky posits, Apple is now run by an operator (Cook) not a creator (Jobs).
The piece is a compelling obituary for Apple, the growth stock star. From the introduction of the iPhone in June 2007 through early last fall, as seen in a stock chart, Apple had an epic run:
But then like big pharma watching a star drug go off-patent, Apple has had to contend with a flattening competitive field as the iPhone no longer dominates in an increasingly Android world. Meanwhile, the Apple pipeline has yet to deliver a replacement blockbuster. Since the pace of earnings growth started to slow last fall, the stock has shed shed more than one-third of its value.
But a dead growth stock can have a second life as a pretty compelling value stock. Granted, owning the stock during the transition is not recommended -- and it’s not clear if we’re done with most of the letting go -- but a few experienced value investors are beginning to nibble on Apple. A little financial analysis suggests why.
The T. Rowe Price (TROW) mutual fund group is a pretty interesting microcosm of the Apple transition conundrum. Two of T. Rowe Price’s solid growth-oriented mutual funds, T. Rowe Price Growth Stock fund and T. Rowe Price Blue Chip Growth, have been aggressively selling off their large positions in the first half of the year. For example, at the beginning of the year, T. Rowe Price Growth stock owned about 5.4 million shares of Apple, accounting for 9.5% of the $34 billion fund’s assets. At the end of June the fund owned just 850,000 shares. The fund’s shedding of Apple and the stock’s continued slump trimmed Apple’s position in the growth fund to just 1% at the end of June; Amazon (AMZN) is the top holding at both growth funds.
At a much more measured pace, Brian Rogers, long-time manager of the value-focused T. Rowe Price Equity Income has been building a small stake in Apple. Rogers is the poster manager for how active management can indeed work. Over the past 15 years his large-cap mutual fund generated a 6.3% annualized return, a full two percentage points ahead of the S&P 500.
In the first quarter of this year he stuck a toe - -a very small toe – into the Apple waters; his initial stake was just 0.50% of Equity Income’s $27 billion asset base. In the second quarter another toe went in as the stake grew from 325,000 shares to 550,000 shares. The position is now about 0.80% of fund assets.
Clearly not a high conviction call, but worth keeping an eye on.
The value investors over at the Franklin Templeton Mutual series of funds (the shop Franklin bought from value legend Michael Price in 1996 ) have established bigger footprints in Apple. Mutual Global Discovery, Mutual Quest and Mutual Shares all initiated positions of at least 1% of fund assets in the first quarter. In the second quarter, Global Discovery and Quest added another 2O%+ to their positions; Apple accounted for 1.8% of Global Discovery at the end of the second quarter, and 2% of Mutual Quest.
Over at Legg Mason Value Trust, new manager Sam Peters boosted his Apple stake in the second quarter by more than 25%. During the past year he has traded in and out to maintain a 4% position in the stock, making it his second highest conviction holding, behind JPMorgan (JPM). Yes, this is the fund that Bill Miller nearly ran off the cliff from 2007-2010 with some large bets that went seriously sour. But since Peters formally took over a little more than a year ago he has quietly posted benchmark-beating returns. The large-cap fund ranks in the top 10% of similar funds over the past year and year-to-date, according to Morningstar.
It’s not especially hard to see the value case for Apple.
Yes, EPS fell off a very high cliff, but with it so did the stocks’s forward valuation. Again, if you rode that down, you’re pissed. If you’re looking in from the outside, however, you see some opportunity to pick up a much cheaper stock that continues to rake in revenue.
Moreover, in the first quarter of the year (Apple’s second quarter), management pretty much showed growth investors to the exit door when it announced plans to increase its stock repurchase plan from $10 billion to $60 billion by the end of 2015. That’s a signal it knows it can’t necessarily add enough value through organic earnings growth. At the same time, growth investors aren’t exactly interested in the fact that Apple’s new dividend policy has already paid out $7.5 billion over the past year.
For value investors that’s a nice cherry on top, especially given Apple’s ability to keep that dividend growing. Over the past 12 months, the dying growth stock still managed to generate $46.50 per share in free cash flow, a 6% rise over the prior year.
In terms of growth, the one given at Apple going forward is that it will be able to deliver plenty on the dividend front.
Carla Fried, a senior contributing editor at ycharts.com, has covered investing for more than 25 years. Her work appears in The New York Times, Bloomberg.com and Money Magazine. She can be reached at firstname.lastname@example.org. You can also request a demonstration of YCharts Platinum.