2020 has been a year that will stand out in the history books. Financial markets have seen their own share of history in 2020, including significant inflection points, both those readily apparent, and those that have existed behind the scenes.
In the energy sector, March 9th, 2020 was a significant inflection point, where many energy equities, including Occidental Petroleum (OXY) declined over 50% in a single trading session, and alternatively, leading natural gas equities, including EQT Corp. (EQT), Cabot Oil & Gas (COG), and Southwestern Energy (SWN) actually finished higher amid the energy carnage, as I chronicled and outlined in the following two public articles.
While natural gas equities have shined in the energy complex in 2020, energy stocks, and value stocks have generally continued to be out-of-favor, however, the inflection point might have been reached on November 9th, 2020.
Sometimes an inflection point is obvious, hitting an observer over the head, and sometimes it is more discreet, requiring some time to appreciate what has transpired. With energy stocks, which are the fulcrum of the value opportunity, continuing to outperform this past week ending Friday, November 20th, 2020, including the Energy Select SPDR Fund (XLE) rising 5.7%, the SPDR S&P Oil & Gas Exploration & Production ETF (XOP) rising 6.6%, and the VanEck Vectors Oil Services ETF (OIH) rising 10.9%, while the SPDR S&P 500 ETF (SPY) declined 0.8%, and the Invesco QQQ Trust (QQQ) declined 0.2%, market participants may look back to November 9th, 2020, and view it as a line of demarcation between the “Have’s” and the “Have Not’s”.
On May 13th, 2016, I wrote a public Seeking Alpha article stating that Apple was trading at its cheapest valuation in a decade.
The total return for AAPL shares since that articles publication was close to 400%, with the S&P 500 Index up roughly 60% over this time frame.
In 2020, I have been more bearish on AAPL shares, securing a 221% gain on AAPL puts, with a February 28th, 2020 closing transaction.
That first sale of the put options was too early, given the melt-down the broader equity markets suffered over the course of March of 2020.
Today is a perfect time to use Apple as a market hedge on the short side, again, as its enormous market capitalization and elevated price-to-sales-ratio will make it hard for shares to move higher going forward.
“I will go to my grave… believing that really loose monetary policy greatly contributed to the Financial Crisis. There were obviously problems with regulation, but when we had a 1% Fed Funds rate in 2003 after, to me, it was pretty obvious that the economy had turned (up) and I think the economy was growing at 7% to 9% nominal in the fourth quarter of 2003 and that wasn’t enough for the Fed. They had this little thing called ‘considerable period’ on top of the 1% rate just so we would make sure that their meaning was clear. And it was all wrapped around this concept of an insurance cut… I’ve made some money predicting boom-bust cycles. It’s what I do. Sometimes I am right. Sometimes I am wrong, but every bust I had ever seen was proceeded by an asset bubble generally set up by too loose policy…”– Stanley Druckenmiller
(Source: Image From Author’s May 2016 Seeking Alpha Apple Article)
On May 13th, 2016, I wrote a public Seeking Alpha article stating that Apple (AAPL) was trading at its cheapest valuation in a decade. The total return for AAPL shares since that article’s publication was close to 400%, with the S&P 500 Index up roughly 60% over this time frame.
(Source: Author, Seeking Alpha)
More recently, I have turned somewhat bearish on AAPL shares, especially as the company has continued its climb towards the $2 trillion market capitalization mark.
In fact, earlier this year, I purchased January 2021 puts on Apple shares, and then on February 28th, 2020, I cashed these puts in for a 221% gain, which was too early with the benefit of hindsight, even though I wrote publicly about the risks of COVID-19, including this article, titled “Two Black Swans“, which was published on Seeking Alpha on February 25th, 2020.
Alternatively, you could say I cashed in at a decent time, given the broader stock markets seemingly parabolic rise from its March 23rd, 2020 lows, which has been led by the largest market capitalizations stocks, including Amazon (AMZN), Microsoft (MSFT), Alphabet (GOOGL), (GOOG), Facebook (FB), and of course, Apple.
Whatever logic you subscribe to, I think it is a perfect juncture to take a bite out of Apple shares on the short side again.
I feel this way for three reasons. First, the company’s sheer size and elevated price-to-sales ratio is going to make it hard to grow robustly going forward, secondly, on a broader valuation basis, shares are no longer cheap, like they were in May of 2016, and third, market participants are using the leading growth stocks as a bet on continued disinflationary pressures amdist the COVID-19 pandemic, yet some combination of a vaccine, treatments, or herd immunity is likely to usher in a historic capital rotation towards value equities and economically sensitive equities.
Apple’s Sheer Size Is A Headwind
Apple’s market capitalization at Friday, July 31st, 2020’s closing price of $425.04 is a remarkable $1.84 trillion. In fact, with a 10.47% share price gain during Friday’s trading session, Apple shares added over $174 billion dollars in market capitalization.
Breaking this down further, that $174 billion gain in market capitalization, if ascribed to one company, would make that hypothetical company roughly the 35th largest company in the SPDR S&P 500 ETF (SPY).
For perspective, the market capitalization of Pepsico (PEP) is $191 billion, the market capitalization of Abbot Laboratories (ABT) is $178 billion, the market capitalization of Saleforce.com (CRM) is $176 billion, the market capitalization of Oracle Corporation (ORCL) is $170 billion, and the market capitalization of AbbVie (ABBV) is $167 billion.
Again, for perspective, Apple gained roughly the amount of market capitalization in a single day, that some of the largest companies in the S&P 500 Index have taken lifetimes to build.
Overall, AAPL shares now compromise roughly 6% of the S&P 500 Index (SP500), and with Friday’s move, they should surpass Microsoft as the venerable index’s largest holding, which will be mirrored in State Street Corporations (STT) SPY product.
The problem with being this enormous, is that Apple is going to have a hard time growing revenues, profits, and cash flows at a rate that make a material impact on the overall size of the enterprise.
Building on this narrative, at a trailing-twelve-month revenue run rate of $274 billion, Apple is selling at an almost 7x revenue multiple for the past twelve months, and revenue has not really grown at all from 2018’s annual levels ($266 billion).
On this note, given this price-to-sales multiple, we have to remember what Scott McNealy, the former CEO of Sun Microsystems said about his company trading at a 10x revenue multiple at the peak of the dot-com bubble era.
‘At 10 times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10 straight years in dividends. That assumes I can get that by my shareholders. That assumes I have zero cost of goods sold, which is very hard for a computer company. That assumes zero expenses, which is really hard with 39,000 employees. That assumes I pay no taxes, which is very hard. And that assumes you pay no taxes on your dividends, which is kind of illegal. And that assumes with zero R&D for the next 10 years, I can maintain the current revenue run rate. Now, having done that, would any of you like to buy my stock at $64? Do you realize how ridiculous those basic assumptions are? You don’t need any transparency. You don’t need any footnotes. What were you thinking?’
Now Apple is not Tesla (TSLA), which sports a price-to-sales ratio over 10 (though to be fair to Tesla, revenues could surge higher on higher vehicle volumes), however, with Apple’s revenue growth already slowing to a crawl, and the sheer size of Apple’s revenues being so large, it is going to be hard to grow revenues and profits to simply maintain the company’s stock price anywhere near today’s levels, let alone grow it, at least in my opinion.
Apple’s Valuation Ratios Today Are Head & Shoulders Above Where They Were In May Of 2016
Remember, we just established that Apple shares are trading for almost a 7x price-to-sales multiple, with very little revenue growth the past two years. Building on this narrative, the valuation table image below, with underlying data from Morningstar (MORN), is taken directly from my May of 2016 public article.
(Source: Author’s May 2016 Article, Seeking Alpha, Morningstar)
Notice that back in May of 2016, Apple shares were trading at 2.3 times price-to-sales multiple, a 10.3 times price-to-earnings ratio, and a 3.9 times price-to-book ratio.
Today, those valuation multiples for Apple are 6.9 for the price-to-sales multiple, 32.2 times for the price-to-earnings multiple, and 25.2 times for the price-to-book multiple.
Given these extended valuation ratios, it should be no surprise that Morningstar had a $285 fair value target on AAPL shares as of July 31st, 2020, which is a tidy 32.9% below Apple’s recent closing price.
Growth Stocks Could Be Hurt In A Capital Rotation
It has already been established that Apple is a growth stock without revenue growth, as their trailing-twelve-month revenues of $274 billion are only modestly above their 2018 fiscal year revenues of $266 billion and their 2019 fiscal year revenues of $260 billion.
This flat-line in growth is decidedly different than their large-cap growth peers. On that note, an analyst can say whatever they want about Alphabet, Amazon, Facebook, and Microsoft, and some of these companies are ridiculously overvalued too, in my opinion, however, at least these companies are firmly growing revenues.
Building on this narrative further, we know that growth stocks have outperformed their value counterparts for the better part of 13 years now.
This outperformance has grown amidst the COVID-19 outbreak, with growth stocks actually less sensitive to asset manager’s modeled COVID factors than their value peers.
(Source: Los Angeles Capital Management)
This makes sense as many of the leading growth stocks like Amazon, Netflix (NFLX), and Shopify (SHOP) have actually benefited, on both a relative and absolute basis, from the lifestyle changes that COVID-19 has engendered.
Apple has fit firmly into this camp, with shares making new all-time highs, as they have gotten a revenue boost from more employees working from home, and the resulting technology spending.
The fly in the ointment here is that Apple is really not a growth stock these days, even with their recent quarterly earnings that came in better than expectations, so it has been lumped in with the positive leading growth stock beneficiaries of the COVID-19 pandemic, yet Apple has not yet seen a commiserate, sustainable boost in their business, at least on the same percentage terms as some of their peers.
For example, Amazon is Apple’s closest peer in terms of market capitalization, and Amazon reported earnings on the same day as Apple, and the company topped their consensus revenue estimates by roughly 10% for the second quarter of 2020, showing overall revenue growth of 40% year-over-year that dwarfed their larger capitalization rival, with Apple reporting 11% revenue growth year-over-year.
Closing Thoughts – Apple Is A Terrific Company That Is Significantly Overvalued
Back in May of 2016, I could not say enough good things about Apple’s stock from a value perspective. Today, with Apple’s price-to-sales, price-to-earnings, and price-to-book multiples all significantly higher than they were in 2016, and with the company showing a lack of revenue growth the past three years, I am much more skeptical on shares.
So skeptical, in fact, that I purchased Apple January 2021 puts on January 24th, 2020, and then took a 221% gain on these a few weeks later.
(Source: The Contrarian)
With Apple shares climbing even higher in the summer of 2020 than they were earlier in the spring of 2020 before the COVID-19 outbreak, I think now is the ideal time to use a short position again in Apple shares as a hedge against a broader market decline. This hedge serves dual purposes for me personally, which are protecting my long positions, and guarding against a capital rotation where in-favor stock like Apple are sold, and out-of-favor stocks that are undervalued, like Antero Resources (AR) that I profiled recently here, appreciate.
Given how overvalued Apple shares are today compared to where they were in 2016, it is also possible that Apple’s common stock underperforms the market, and even declines on an absolute basis, irrespective of the broader markets overall direction.
The possibility of outright declines in Apple’s common shares seems farfetched now, with the afterglow of Apple’s recent multi-year bullish performance fresh in investors’ minds, however, we only have to look back to the first half of 2016 to see an environment where Apple’s stock was out-of-favor.
Shares do not have to go all the way back to their May 2016 levels of $90 per share for current Apple investors to suffer, as simply going back to Morningstar’s fair value target of $285 would imply an outright decline of roughly 33% below Apple’s closing price on Friday, July 31st, 2020.
Wrapping up, without a doubt, Apple has been one of the most remarkable growth stories in U.S. business, particularly over the past two decades. Personally, over the last decade, I have owned Mac’s, iPod’s, iPad’s, iPhone’s, and Apple common shares, so you could even say I am a connoisseur of Apple’s products.
Common shares have appreciated by roughly 500x from their 2000-2002 lows, propelling Apple to become the largest market capitalization stock in the world. Whether you own Apple shares outright or not, most investors have an implicit stake in the company, because Apple has a roughly 6% weighting in the S&P 500 Index and a roughly 12% weighting in the Invesco QQQ Trust (QQQ).
The significant weightings in benchmark indexes are a result of historic run of growth, and many traders front running valuation insensitive and price insensitive index/ETF buying, however, Apple’s revenue growth has slowed and stalled, and its once formidable free cash flow yield (the company generated over $66 billion in FCF in the past twelve months) has shrunk to under 4% as its market capitalization has ballooned. Apple remains a fine company, just an expensive one on a valuation basis, and this poor valuation starting point is a recipe for poor future stock returns.
Disclosure: I am/we are short SPY in a long/short portfolio, I plan on shorting AAPL shares again via put options in the next 72 hours, and I am long AR.
Additional disclosure: Every investor’s situation is different. Positions can change at any time without warning. Please do your own due diligence and consult with your financial advisor, if you have one, before making any investment decisions. The author is not acting in an investment adviser capacity. The author’s opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies’ SEC filings. Any opinions or estimates constitute the author’s best judgment as of the date of publication and are subject to change without notice.
This weekend, I was putting together performance data (more to come on this front shortly), and the continued out-performance of growth equities was noticeable enough that I decided to pen an article for members about it.
Going back a decade, growth stocks have trounced value stocks in the United States, and the longer-term out-performance of growth stocks over their value counterparts is eye-opening.
Thus, I wanted to highlight the performance differential, to explore what it means, and contemplate how it will be resolved.
Growth Is Outperforming Year-To-Date
Compared to a historically low equity volatility year in 2017 (really almost all financial assets had low volatility in 2017), volatility has certainly picked up in 2018. However, that has not impacted the out-performance of growth equities, yet.
Year-to-date in 2018, the iShares Russell 1000 Growth ETF (IWF) is higher by 12.3%, significantly outpacing the returns of the iShares Russell 1000 Value ETF (IWD), which is higher by 1.7%.
Looking at smaller capitalization equities, the same trends are holding true, with the iShares Russell 2000 Growth ETF (IWO) higher by 13.3% year-to-date, while the iShares Russell 2000 Value ETF (IWN) is higher by a still healthy 7.5% year-to-date through Friday, August 10th, 2018.
There is no question that growth stocks continue to lead their value counterparts in 2018.
This trend has persisted for roughly a decade, with sporadic periods of value out-performance, including most of calendar year 2016, yet these periods of value out-performance have been false starts thus far.
Growth Is Outperforming The Past Decade
Going back ten years, the iShares Russell 1000 Growth ETF has increased 215.6%, while the iShares Russell 1000 Value ETF is higher by 126.2%, which is not to shabby on an absolute basis, or even a relative basis compared to most international and emerging market equity ETF’s, yet the performance differential versus the Russell 1000 Growth is historically wide.
This performance differential persists in the small-cap arena too, with the iShares Russell 2000 Growth ETF higher by 189.5% over the prior decade, while the iShares Russell 2000 Value ETF is higher by 138.7%.
Interestingly, the performance gap between the Russell large-cap growth and value ETF’s, which stands at 89.4% over the last ten-years, is larger than the the performance gap between the Russell small-cap growth and value ETF’s, which have a 47.8% performance differential.
Clearly, the Russell 1000 Growth ETF has been positively impacted by the historic run in mega-cap growth stocks, including Amazon (AMZN), which is up 2242.9% over the past decade, Apple (AAPL), which is up 866.8% over the past decade, Alphabet (GOOGL), which is up 405.6% over the past decade, Microsoft (MSFT), which is up 397.8% over the past decade, and Netflix (NFLX), which is up a remarkable 7697.4% over the past decade.
On this note, one of my biggest mistakes in what was a wonderful 2008-2010 time period for me personally investment wise, was not identifying what was rare, which was growth, in a low growth world.
Elaborating further, I had invested substantially in the first video streaming company that I am aware of, which was Intraware, in 1999, so I saw the potential for a stock like NFLX, yet while NFLX was playing out in front of my eyes, my value bias prevented me from investing in what was a phenomenal growth opportunity.
Recent Small-Cap Out-performance Holds Clues
If you are a market historian, you know that the best long-term asset class, in terms of performance, is small-cap value. The Ibbotson data, which is now part of Morningstar, illustrates this clearly.
However, looking at the data above, small-cap value stocks, as measured by the Russell 2000 Value ETF, are the second worst performing group over the past decade, trailing large-cap growth equities, small-cap growth equities, and only moderately ahead of large-cap value stocks, as measured by the Russell 1000 Value ETF.
Thus, small-cap value stocks (incidentally many of our favored U.S. commodity equities, which are illustrated on the Top-Ten List, are now classified as small-cap value equities) are due for a period of out-performance, which would be in sync with the long-term Ibbotson data.
Somewhat surprisingly, given the perception of today’s stock market leadership, U.S. small-capitalization equities have out-performed their large-cap counterparts year-to-date in 2018 as shown above.
This raises some interesting questions, which I am brainstorming out loud as follows:
Perhaps the U.S. stock market is not as near rolling over as believed, or as projected, as a resurgence in U.S. small-cap equities would not align with the narrative of narrowing market leadership?
Perhaps we have not reached the late-stage cycle of the investment cycle road map?
For someone who has believed that the current U.S. equity market is historically overvalued, specifically even more overvalued than 1999 or early 2000, I am trying to think outside-the-box to see how the current high valuation investing could be resolved.
Look For A 2000 Repeat Of Value Over Growth
This past week, I officially turned 41, and looking back to 2000, when the Russell 1000 Growth and Value ETF’s were just formed, I am officially feeling older.
As you can see from the charts above, the Russell 1000 Growth & Value ETF’s came out in late May of 2000. From late May of 2000, through year-end 2000, the Russell 1000 Growth ETF was down -17.2%, while the Russell 1000 Value ETF was higher by 8.6%.
From memory (the Russell 1000 Performance calculator will verify), the Russell 1000 Growth Index finished 2000 lower by roughly -22%, while the Russell 1000 Value Index finished higher by roughly 7%.
Thus, in one year, a significant portion of the growth minus value performance gap, that had built up over the prior decade, from 1990 to 1999 was erased.
Building on this narrative even further, the 2000-2002 bear market in U.S. equities, which saw the S&P 500 Index (SPY) decline by roughly 50% from peak to trough, occurred alongside a very mild recession.
Could something similar happen today?
Going even further, could we see the S&P 500 Index, and more specifically the historically outperforming growth equities, decline substantially outside a recession, or even if economic growth picks up?
Takeaway – Growth’s Run Over Value Is Getting Long In The Tooth
Growth stocks have dominated value equities over the past decade.
This has emboldened growth investors, and taken the spirit out of value investors.
The comparisons between today’s market environment, and the one that existed in the late 1990’s is apt, and this is coming from someone who was an active, contrarian value investor in both time periods.
Both growth and value investors should be on the lookout for a reversion-to-the-mean in performance.
When this inevitably happens, I think the performance-gap between growth and value investments will be bigger, in-favor of value, than it was from 2000-2002.