Last Thursday January 24, 2012 shares of Apple stock (AAPL) dropped 12.36% after announcing quarterly earnings that failed to meet analyst expectations. I’m going to admit that I was very interested as I watched all of this unfold because I suspected the market was greatly over reacting. After the large drop, Apple stock was trading down close to 10 times earnings (P/E near 10) and had a dividend yield close to 2.3%. When I looked over the fundamentals, I think the company looks strong and I couldn’t understand why the market is not willing to pay as much for $1 in earnings from Apple compared to other companies like Microsoft, McDonald’s or Wal-Mart (each of whose P/E’s are in the mid teens).
Part of me wanted to take advantage of this situation and initiate a position in Apple. However, Apple isn’t the kind of company I would normally buy. The fundamentals of the company appear great to me, however they are not a dividend growth company. They only last year announced their first dividend payments and time will tell what their policy will be in regards to increasing that dividend. While I was tempted, I decided it best to follow my dividend growth investing rules and not regret a purchase that doesn’t fit my investing philosophy.
Besides the lack of historical increasing dividends, one other thing worried me about Apple. Currently Apple is the hot company with the hot products. Seems everyone has the last IPhone and IPad. These are great, innovative products that won Apple many fans in the consumer market. Unfortunately, I don’t know how long these products will continue to be leaders in their respective markets. Blackberry used to be the hot phone to have and that was replaced by the IPhone. How long will the IPhone continue it’s dominance before something replaces it. I’ve already heard great reviews of the Samsung Galaxy phones. Also the IPad is seeing competition from Google and Microsoft in the tablet market. How long will it be before some other company comes out with something better that everyone decides they want. If Apple can’t innovate going forward, I’m not confident in their earnings ability. This is another reason I wasn’t interested in buying Apple even if I thought it was trading at a great price. I have no idea how long Apple’s products will be popular and continue to generate the great earnings they are currently producing.
I believe that ultimately stock prices are driven by earnings. As investors, we must always buy stock in companies whom we believe will increase their earnings going forward while we are owners. As dividend growth investors, this is very important because without earnings growth there cannot be dividend growth. Without earnings growth there will also unlikely be market increases in stock price. Our total returns will ultimately suffer. If a company is unable to grow earnings, they should be paying out the majority of their current earnings in the form of a dividend. If they are retaining a large portion of earnings and yet are unable to provide future growth, then we as investors must decide that this company is not doing a good job with retained capital and we should look elsewhere.
In regards to Apple, I have no idea if they will be able to continue growing their earnings. If I invested in Apple I would be very afraid that their current products will lose popularity and earnings will fall. If people begin looking at other choices rather than the IPhone and IPad, earnings from those two products will fall. Apple must continue to innovate with new product releases if they hope to continue growing earnings. From what I’ve seen so far after the death of founder Steve Jobs, I’m not sure they will be able to. Therefore, I’m not too confident in the earnings of Apple going forward. So even though I think the market overreacted and shares of Apple look like a good buy currently, I will not be buying. A company is only worth what they will earn in the future. I’m not confident in Apple’s outlook.
I like Apple products and hope they prove me wrong so I can have some more neat gadgets to play with.
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