Gordon Reid, president and chief executive officer, and Don Lato, managing director, equities, Goodreid Investment Counsel Corp.
Don Lato: We bought Apple in the summer of 2006 in the low $60s. We've trimmed it for portfolio management purposes, but we've held it all the way through, and continue to buy it.
Gordon Reid: We run screens for all our stock positions, looking for companies improving on their own history, that rank well against their peer group and have attractive valuations. Apple hit the screens, and we started doing more work.
Mr. Lato: We bought Apple on a valuation basis, but the catalyst we were looking for was increased penetration by Macs into the PC market. At that time, Apple had 3 or 4 per cent of the PC market, so there was a long way to go, and we felt that was going to give the company enough earnings power to more than justify the price.
Mr. Reid: We do like to have the wind at our back, and in the past 20 years we've seen a technology revolution that is allowing that sector to grow at multiples of GDP growth. And we seek out the best in this growing area.
Mr. Lato: From that initial position in 2006, [our investment]has compounded at about 40 per cent a year in, basically, a market that's down. The S&P 500 index is down about 15 per cent from where it was in June, 2006.
Mr. Reid: This company has grown at a rate that has been quite astounding, and we're very gratified that the stock price has kept pace.
When we bought the stock, it … had earnings of about $2.50 a share. The price has grown fourfold, but the earnings have grown fivefold. So there's more reason to think today there's better value in Apple stock than there was when we first bought it.
Thinking of investing in Apple?
You often hear investment professionals talk about it trading in the 20 to 25 times range. It doesn't. Apple has about $45 a share in cash on the balance sheet, and that cash should be deducted before determining how much investors are willing to pay for each dollar of earnings. So, by our calculation, it's trading at about 13 or 14 times earnings, extremely cheap for a company that's growing at the rate it is.
Mr. Lato: We continue to make the point to our clients who say, isn't enough enough? We don't think it's enough, because Apple is still a very cheap stock.
Mr. Reid: At the time we bought it, the iPhone didn't exist, the iPad didn't exist, the App Store didn't exist; next year, over half of Apple's revenue will be from products that didn't exist four years ago.
Mr. Lato: Macs and related products are 41 per cent of total sales, and iPods are still a significant factor at 19 per cent, but iPhones, apps and iPads will go over 50 per cent next year.
Mr. Reid: And the new product lines have very high margins. These are running in excess of 50 per cent gross margins. IPhone is, in fact, about 60 per cent.
Mr. Lato: Margins are that high because Apple, with its cachet, is able to command that price.
Mr. Reid: The iPhone is Apple's dominant product, and the smart phone market is very early cycle.
Industry estimates say that over the next four years, the smart phone market could quadruple in size. So there's a huge opportunity, and we think Apple will get more than its share.
The refresh market plays a big role, too. Apple comes out with an iPhone, a 3G, a 3GS, next will be a 4G, and that's all part of a product cycle.
Mr. Lato: Just as the iPod changed dramatically over its history, so too will the iPhone and the iPad.
Mr. Lato: Obviously, the stock has exceeded our expectations. But we bought it for the same reasons we buy all our stocks: Apple had good valuations relative to its history, its peer group and its earnings growth, and if you start on that basis, you leave yourself in a position where good things can happen.
Mr. Reid: There's an old adage we like: The prices of stocks are the slaves of earnings. If you have a company that's performing well, executing well, growing well, the stock price will follow.
Mr. Lato: Look at the expected earnings, and what you're paying for them. There are great companies out there that have great potential earnings, but if you're paying too much for them, it's just that much more difficult to make an exceptional return.
Mr. Reid: There are fundamentals and there is what you're paying for those fundamentals. And those two things have to be coupled to make a determination of value.
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