Apple Has ‘Advantages’ That Are Too Big To Ignore
It’s no secret Apple is on a roll. Still, the numbers are staggering. The iPhone maker’s shares have risen 57% year-to-date, making Apple Inc. worth just under $2 trillion.
Allegations of unfair and anti-competitive actions have surfaced in a lawsuit against Apple by Epic Games. In the filing, the plaintiff asserts Apple Inc. “is bigger, more powerful, more entrenched, and more pernicious than the monopolists of yesteryear.”
Whether Apple’s actions constitute monopolistic practices will be decided in the courts. However, it is clear Apple has several key “advantages” over other companies.
Advantage #1: The Fed
As of June 24, the Federal Reserve printed $8.7 billion to buy corporate bonds.
The Fed released a list of nearly 800 companies whose debt it intended to buy to help support financial markets. The individual bond purchases are executed through the newly created Secondary Market Corporate Credit Facility (SMCCF).
Among the top 15 weighted holdings in the Fed’s portfolio, Apple ranks number five.
Why is the Fed buying Apple’s bonds?
Surely, there must be better candidates for stimulus dollars. After all, this is the most successful company in the world.
The pandemic and government shutdown wiped out over 80,000 small businesses from March 1 to July 25. Among those, about 60,000 were local businesses with fewer than five locations, according to Yelp data.
Apple does not need extra help from the Fed. The company has no problem accessing capital at favorable rates. In fact, last week Apple announced it was issuing 0.55% bonds maturing in 2025, 1.25% bonds maturing in 2030, and 2.4% bonds maturing in 2050.
According to Apple Insider, Apple plans to use the money in stock buybacks and to pay dividends, along with other “general corporate purposes.”
In other words, Apple uses debt to enrich shareholders, not hire more workers.
If the Fed wants to promote equality, as Chairman Powell has recently said, it should explain how buying the bonds of the richest company in the world helps that cause. And what about those other cash-rich, foreign firms on the list? How exactly does buying the bonds of Toyota benefit the American economy?
These are important questions, because every time the Fed prints new money, it devalues the existing paychecks and savings of Americans.
“I do think it’s moral hazard,” said Kathy Jones, director of fixed income at Charles Schwab, who also told CNBC, “I think it’s something they’re going to have to deal with when things settle down. There will be accusations that they committed money in ways that didn’t make sense and didn’t help the average Joe.”
Advantage #2: The Passive Bubble
1984 was George Orwell’s chilling prophecy about a future devoid of free and independent thought. When that year rolled around, Steve Jobs saw an opportunity to differentiate his fledgling company from the industry Goliath of the time, IBM.
Yet, if we fast forward to 2020, Apple is now Goliath—an irony captured in the following parody video.
A boom in passive indexing, which systematically rewards larger companies, has made the crown of Goliath worth a lot more in 2020 then it was 1984.
In my last piece for Forbes, I profiled how passive ETF inflows may be creating a tailwind for certain stocks. Passive money ignores valuation and invests in the past, because it is a style that systematically allocates capital pro-rata, based on existing market capitalization. So the bigger a company is, the more money it gets.
Apple is a lot bigger than its former rival, IBM. Over the last five years, $1.33 trillion worth of passive money has flowed into Apple, while IBM saw passive inflows of $9.7 billion.
Five years ago, IBM traded at a price-to-sales ratio of 1.8. Today, the stock is cheaper at 1.5. Meanwhile, Apple shares, which used to trade at a price-to-sales multiple of 3.1, are more than twice as expensive at 7.0 times sales.
The valuation and beta profile of the S&P 500 has also changed over the last five years. Top stocks, like Apple, are seeing higher valuations, while beta—a measure of perceived market risk—drifts lower. Meanwhile, value stocks, like IBM, and smaller segments of the S&P 500, have seen their betas rise as valuations stayed flat or receded in some cases. It is particularly interesting how the smallest decile of the market has shifted on these measures compared to the top decile.
Apple: Too Big To Ignore
The current stance of monetary policy is the most aggressive intervention in the 107-year history of the Federal Reserve. By expanding its balance sheet to hold long-term interest rates down, the Fed is buying bonds to prop up the biggest companies, which provides an unfair cost of capital advantage.
The fact Apple can borrow at 0.55% and has a cost of equity of just 2.9% (inverse of that 35 P/E ratio)—enables them to overcome capital allocation stumbles smaller firms could never get away with. Like spending $5 billion on a fancy corporate campus, just before a commercial real estate bear market.
Apple paid for its lavish Cupertino campus last Wednesday, when the stock went up 3%, and the company’s market cap rose to $1.93 trillion from 1.87 trillion.
However, all the rapid inflows are inflating Apple’s valuation at a speed that vastly outpaces the company’s fundamental growth.
Apple is expected to growth sales by 4.8% and 12.6% in 2020 and 2021, respectively. Earnings per share are expected to rise 8.7% and 16.9% over that time. Yet, Apple’s stock is up more than 100% in the last year alone. This kind of trajectory is clearly not sustainable.
Apple trades at the largest premium to the S&P 500 in a decade, and is at least 3 standard deviations expensive compared to the 5-year trend on most valuation metrics. Remember, one of the biggest drivers of return is the valuation of an asset when you buy it. At these levels, it will take years of sales and earnings growing, with zero stock appreciation, to reset Apple’s valuation to a normal level.
Unfortunately, America’s retirees have never been more fully loaded in the name. Thanks to lobbying efforts by firms like Blackrock and Vanguard, nearly 85 cents of every incremental retirement dollar now flows into a target date fund, of which Apple is a top equity holding.