First let us capture the market snapshot: As I write this Tuesday morning the S&P 500 is down about 1.8%, Nasdaq is down about 1.1% and Dow Industrials is down about 1.9% but Apple (AAPL) is up about 2% already with volume of 18 million shares. Well, this picture says a lot. Institutional money is pouring into Apple stock. So retail investors are scratching their heads and are asking if they should take a position in Apple. My answer is simple: if you really have to buy this stock then buy it today, otherwise forget about it. Before you know it, AAPL might be hitting $450/share in the next few weeks if inflows of institutional money stay the same. But do not initiate a new position at $450/share.
Risk for Apple stock is rising exponentially versus the potential for reward with a run up in the stock every day. Some price targets easily put Apple stock at $550/share but those targets might just remain ever-elusive. While a safe-haven alternative in today's market, Apple might hit $500 as late investors still try to play catch up but Apple is becoming riskier now on a daily basis. The reasons are numerous. Apple has stayed at the forefront of technology in past years but eventually technology will catch up with Apple. What I mean is that Apple created an awesome product with iPhone (iPad is still just a bigger iPhone for me) and then true to its name Apple created an eco-system of Applications (Apps as we call them) around it. And iOS made those Apps tied to Apple devices very closely. But technology is slowly and steadily catching up. We believe that iOS, Android, and other OS will soon become immaterial. Technologies like HTML 5 will make any simple App able to run on any device. While some high-end games with extreme graphics might still require close ties with the underlying operating system of the device, most users would not have to worry about the Apps ecosystem any more.
Another problem with Apple is that it is a company which has since inception believed in closed architectures as opposed to giving users a choice. While it has worked in recent products, we as investors should not forget about Apple pre-2004. Apple was following the same mindset back then as it is now. In fact, that mindset is even more pronounced now that Apple has major successful products. But with Steve Jobs not being involved in day to day operations, we don't think that Apple will know when technology passes it by this time around.
In reality, there are better smart phones around even now with better form factor, better battery life and better open platform. But users who have become accustomed to their iPhone Apps will find it difficult to switch. This will change slowly as users slowly move to using Apps even on home PCs and other devices like TV, Blu-Ray players etc. which are non-Apple. Users will be pleasantly surprised to know that those same apps can be used on their Apple or non-Apple phones as well. At that point, Apple's eco-system will be broken. Then Apple will be left to compete with other device makers as it unsuccessfully did in the PC market for years before hitting the gold mine with iPods.
It's hard to predict, though, where the stock price will be before this technological transition takes away Apple's dominance. But we think that $550 might turn out to be a very hard to hit target price even for Apple. Let us not forget a very similar and very recent story about Netflix (NFLX). As the stock was hitting new highs (now down about 40% in just 3 weeks), Netflix's management was thinking of newer ways to justify that price while forgetting about the basic business and its customer base. It's not a surprise that an unjustifiably high stock price becomes a distraction for management very easily and starts hurting the core business itself.
Lastly, with so much institutional money parked in the stock, any moves in Apple stock might be exaggerated. With downside potential increasing on a daily basis, the risk-reward profile for Apple stock may soon become totally unfit for retail investors. We expect the stock to have a sharp pullback before the end of the year as holiday sales are already getting baked into the stock price. Beyond $450/share in Apple we would advise investors to wait and watch Apple only from a distance.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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