Mike Lipper’s Monday Morning Musings Blog
Editors:Frank Harrison,1997-2018,Hylton Phillips-Page, 2018
Lesson for All Investors
The biggest benefit to all stock investors is what the piercing of the $1 trillion level didn’t do! Often such a press event generates a follow through. That the Apple $1 trillion event did not immediately trigger a speculative surge probably means that there is more time until the top, which is often the result of a great amount of speculation.
In a speculative surge one can imagine commentary on the next one to five companies reaching that level, or when Apple (*) reaches $2 Trillion. These types of comments generally lead to a speculative surge, causing the next stock market decline. The absence of large scale speculation suggests that the next decline will likely be one that’s more cyclical in nature, about 25%. If on the other hand we are cursed with a speculative surge sucking in more of the public as well as undisciplined institutions, it may lead to losses of half the invested capital. As bad as that would be, what would be worse for the economy and society would be a wave of punishing regulation and legislation, because that would curtail the eventual recovery and the return to a growing economy. Thus, the biggest benefit is that with less than a catastrophic decline, we can hold for the longer term and subsequent market recoveries.
(*) I have been a long-term investor in Apple for personal accounts
Investment Executive Wake-Up Call
Contrary to what many believe, Apple is not primarily a cell phone company. It is a champion supply chain manager. Also, it is a marketing channel leader, a capital-lite massive capital generator, and a post-integrator. Post-integrator refers to organizing activities that are not primarily integrated along horizontal or vertical business lines. Other companies have done one or more of these things, but Apple has become the poster case for doing these things differently in the new world of stock investing and political management.
In the 1950s we learned in college about integration, not so much racial integration, but business structure integration. Corporate leaders were vertically integrated by building all the critical inputs to their product lines or horizontally integrated by selling everything essential to the customer. I remember being a guest in a few corporate dining rooms where my hosts were very proud of their internally produced ice cream (an insurance company), or a prized omelet chef (a brokerage house). The executive dinning rooms were believed to be a source of competitive strength.
As a junior securities analyst I was assigned to follow the eight major steel companies using only annual reports and brokerage reports. I found that each of the companies was reporting differently from each other. I also learned the major differences between the largest steel companies and the next tier was their degree of integration. The largest steel producer was also the world's largest cement producer, which had its own transportation system and produced a good bit of the electrical power it consumed. When it needed to get additional capital, the chief financial officer walked across the street from their financial office in Manhattan to a Wall Street investment or commercial bank to get the money. (This was the same pattern for the world's largest auto producer, as well as for the world's leading oil company.)
Contrast this with the $1 Trillion Apple (*) of today. While not completely like Nike, which has no manufacturing efforts, Apple makes very few of the components used in its products in its own factories. Its factories are essentially the final assemblers of the completed products, with sub-assembly work done by others. This is the supply chain task that Steve Jobs assigned to Tim Cook, who built the modern global Apple. In so doing the company transcended governmental and cultural borders. Thus, national political leaders have been out-flanked, and taxes and other trade barriers have become multi-national competitive fields of play.
To some degree the competitive advantage that Apple has developed is channel management, with intense focus on the level of completed product inventory, for what is probably the world’s largest grossing store change. Interestingly, Apple built the stores at the very time that large department store chains were closing unproductive stores. There is a major difference in Apple stores, both from the general department store and the stores of other mobile phone manufacturers. The difference is the sales floor and the sales force. Not only is the sales force knowledgeable and caring, but they reflect similar demographics as their expected customer base. The network of Apple stores in most major cities of the world supports both the local market and travelers with some critical in-person tech support, which is most appreciated by the traveling and spending population.
Apple’s profit margins and their low but growing dividend payout produces a prodigious amount of excess capital, which means that the company is not dependent on Warren Buffett, as he’s mentioned, and most of Wall Street.
The $1 Trillion lesson for the directors of research of investment groups is that they have been assigning the wrong analysts to follow Apple. They have had primarily technology analysts follow the stock. These analysts have focused on the technical specifications of Apple’s products relative to other manufacturers. What they’ve found is that current Apple specifications are not as impressive as others, but they charge more. Thus, they join the large number of professional Apple haters that have been successful in creating periods when Apple’s stock price has declined absolutely and relative to competitors.
What the technology analysts miss is that Apple customers will pay a premium price for products and services that effectively communicate with them. Customers want solutions to their problems. Some of these problems are new to the customers but address important needs. If I were running a major securities research effort I would assign Apple to a team of fashion retail analysts, bank analysts, demographers, and field analysts covering the use of office supplies. This approach would have identified Apple’s strengths sooner than those focusing on technical statistics.
The future is unlikely to be an extrapolation of the past, thus different analytical and investment approaches will be needed to survive and prosper. In the future we will be presented with various opportunities and risks.
Indirect Apple Winners
The second largest equity owner of Apple shares is Berkshire Hathaway (**), which probably owns close to $50 Billion of the stock. The company announced its second quarter earnings on Saturday. From a long term investor's standpoint, while it was nice that the company’s investments rose, including their derivative positions, it is much more important to investors that the operating earnings rose beyond the lower income taxes paid. Casualty insurance operations recovered largely through an increase in the premiums generated. In addition, the railroad gained as there was more freight moved, and earnings from utilities rose because more capacity was brought on line. In brief, Berkshire’s results reinforce other data that US business is getting better and the reduction in income taxes at almost all levels helped.
(**) I have been a long-term investor in Berkshire Hathaway for personal accounts
The careful investor should always look at what could go wrong. This could possibly be summed up in one word, CHINA. A good bit of the freight being moved on the railroad is to and from China. If the level of threatened trade with China is not replaced, earnings could fall. The US stock market is beginning to worry about that. Five out of the ten worst performing mutual funds this week, as published in Barron’s, were primarily invested in China.
Conclusion
Investors can learn a lot by studying two of the most successful companies in the world as they focus on the future.
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A. Michael Lipper, CFA
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