About a year ago, Apple stock (AAPL) traded at $92 per share. Right now, it is trading at $155 per share. This significant June-to-June swing of 68%–a little over 70% when you include dividend payouts—gives students of the market much to analyze and reflect upon.
The theory that the stock market is a near-perfect calculator of the intrinsic value of a business is once again debunked. Apple is the largest business in America. Its profits have vacillated between $45 billion and $48 billion the past three years. The new project announcements and cash build-ups have proceeded as expected. There haven’t been any crazy events, such as annexing Google, that would justify a massive reorientation due to unpredictable circumstances.
And yet, the value of the stock changed 70% in a year. Does anyone out there truly believe that Apple is worth 70% more now compared to last June? Of course not. There’s nothing you can point to that would justify that dramatic of a one-year change. Therefore, you’re left with only one conclusion: Either the market had it wrong when it was valuing Apple at $92 per share last June, or it is wrong valuing it at $155 now. Either conclusion rebuts the notion that prices are always rational.
And that is for the largest company in the United States that has hundreds of millions of people analyzing and reappraising it every day. If even Apple is subject to irrationality, imagine how irrational the pricing must be for the local bank with a market cap of $100 million that only sees a couple hundred shares trade each day.
People wrongly infer changes in the fundamentals of a business when the price of the stock shoots up. A quickly rising stock price is not necessarily a harbinger of higher profits. Likewise, a quickly declining stock price isn’t proof that core profits have deteriorated. These two things often overlap, though it is not a requirement that they do so.
Apple is a business that has proved this point over the past several years. In 2015, Apple stock earned $9.22 per share on $53 billion in profits. This year, Apple is expected to earn $9.20 per share on $47-$48 billion in profits. The reason why profits have held steady is that Apple has repurchased 300 million of its own shares so the $5 billion decline in profits is offset by a decline in the share count from 5.5 billion to 5.2 billion.
Even with a new phone launch, profits will likely barely creep above $50 billion. It is probably going to take 2-5 years before Apple eclipses its 2015 high-water mark of $53.3 billion in single-year profits.
The important takeaway is that the 70% gain over the past year has largely been driven by a change in sentiment surrounding Apple rather than any change in its profitability. It is basically earning the same amount per share that it earned in 2015. Apple’s profits changed all that much in the past year, but the investor community’s perceptions of those profits and expectations for the future have. But it is noteworthy how much people conflate a favorable change in the stock price with a favorable change in the business conditions.
Apple’s weighting in the S&P 500 is still reasonably, despite its recent 68% gain in market cap. Considering that the S&P 500 is market weighted, you might expect a 70% gain from the largest component in the index to reach crazy proportions. But largely thanks to a broader market rally among other components, the 68% increase in market capitalization hasn’t titled the S&P 500 towards absurdity.
Apple is valued at $812 billion. The entire S&P 500 index is valued at $20.6 trillion. That means a true market cap weighted S&P 500 index will only be putting 3.94% of its funds into Apple. When someone says they’re an index fund investor, the reality of their household finances is analogous to “I choose to invest about $4 out of every $100 in my savings into Apple, and I will proceed with that allocation until Apple grows faster or slower than the other 499 components that I own.”
That is not an outrageous allocation for the largest business in America. Typically, AT&T, ExxonMobil, IBM, and General Motors comprised 3-5% of the index when they were the largest business in America (I use the Dow Jones as a reference point for when you trace the 20th century prior to the existence of the S&P 500.) The largest ever allocation occurred when IBM barely crossed the 10% mark in the Dow Jones in the 1960s. Apple’s position as about 4% of the index is in line with the allocation of the largest American business historically, and isn’t even all that unusual for Apple’s allocation over the past 3-4 years. That extra $350 billion in market cap only translated into an extra 0.4 or so weighting in the S&P 500.
Conclusion: I regard with suspicion any argument that says market investors correctly assess value of businesses, as a 70% change in the most liquid publicly traded business in the world in a short period of time strongly suggests either an underestimation of value on the front end or an overestimation of value on the back end. Despite this share price change, there hasn’t been a whole lot of change in either Apple’s profit fundamentals or its weighting in the S&P 500. Each of these notions individually may seem intuitive, but when you see how they all interact together, the overall mix of these data points is a bit more counterintuitive and not what I would have initially guessed without taking a hard look.