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Is This The Real Reason Why You Should Be Selling Apple?

Meena is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Apple (NASDAQ: AAPL)'s "battle lines" are starting to shape up rather clearly. On one side, we have the fundamental investors, who are deeply committed to the stock, due to its superior track record, attractive valuation multiples, boatload of cash, and breadth of product offerings. On the other side of the aisle, we have the technical analysts, who believe that the "death cross," accelerated volume, and a weak MACD are just a few of the reasons that you'd be better off avoiding AAPL.

Is the worst yet to come?

On CNBC yesterday, one esteemed chart-watcher was calling the top on Apple. Tom McClellan, Editor of The McClellan Market Report, discussed his sentiment toward the stock, mentioning that its chart compared eerily with those of RCA in the 1920s and Microsoft (NASDAQ: MSFT) in the early 2000s. McClellan had quite a bit to say; here are the highlights:

"What a stock price pattern tells you, is not so much about the company; it tells you about the people that are invested in it, and how they are behaving [...] what the resemblance is saying to us is that the behavior of the investors in RCA in the twenties, and the behavior of the investors in Apple now, is almost exactly the same. There is a set of physics involved with putting in a top in a major tech bubble company like Apple, or like RCA, or like Microsoft and others in 2000 [...] We're getting a nice pop that's right on schedule this week; a lot more damage to come next year. It's not going to be a good time for Apple the stock."

On the whole, it's apparent that McClellan makes the distinction between Apple "the stock" and Apple "the company," mentioning that from a strategic standpoint, there's still a lot of success to be had. The key point that the market technician is making, though, is that the ebbs and flows of Apple's daily price movement are behaving nearly identical to the movements of "major tech bubble" stocks like 1920s-era RCA and 2000s-era Microsoft.

While pure value investors are likely ignoring this analysis, it's important to note that Tom McClellan was named Timer Digest's No. 1 "long term timer," so there's clearly some pedigree here. In our opinion, the basis of McClellan's argument is philosophically similar to those made by others who mention that investors' psychology is out of whack. Furthermore, the sheer volume of Apple trading that is machine-based - approximately 50-70% - has an impact on the stock's direction as well.

What is the Smart Money doing?

It’s interesting to look at how some of the world’s most successful money managers have been trading the stock. One would think that much of Apple’s malaise over the past few months would involve high-capital investors like hedge fund managers and investment managers, but surprisingly, we actually saw an increase in aggregate fund interest over the past quarter.

Consider the following statistics: at the end of Q2, 147 of the 400 funds we track held a long position in Apple. The value of these funds’ holdings totaled $22.2 billion. One quarter later, 146 of the 400 funds we track were still invested in the tech giant, but something peculiar happened: the value of these funds’ holdings actually increased to $23.7 billion, or a jump of almost 7%.

This data doesn’t include every ‘Mom and Pop’ hedge fund out there, but it does provide insight into what the top money managers of the world are doing. After all, aren’t these the guys/gals we want to be tracking? Over the third quarter, mega-investors like Ken Fisher (+996%) and Dan Loeb (+67%) were upping their positions in Apple significantly. (Here’s Ken Fisher’s newest stock picks) and Dan Loeb’s full portfolio can be seen by following the link.

How does Apple stack up to the competition?

At the end of the day, many armchair analysts have been asking the wrong questions. Instead of comparing the Apple of present to the Apple of yesteryear, we might be better served by matching the company up against its competitors.

In terms of hedge fund interest, Apple is the top stock pick among billionaire managers, and is the No. 1 pick of the 400 funds we track. Above, we mentioned that 146 funds currently hold Apple in our database; this is noticeably larger than the fund interest of Microsoft (96), Google (NASDAQ: GOOG) (132), Hewlett-Packard (NYSE: HPQ) (40), and International Business Machines (NYSE: IBM) (42).

Moreover, total capital invested also gives Apple the advantage. Hedge funds’ $23.7 billion invested in the Cupertino-based company dwarfs the monetary value of interest in IBM ($16.5B), Google ($14.7B), Microsoft ($6.8B), and HP ($1.6B).

But one final way we must compare these tech companies is by way of the fundamentals. While there are plenty of arguments being thrown around that value investors are out of luck until a shift in market psychology occurs (see Is the Problem With Apple How We Trade It?), we choose to believe that some tried-and-true metrics are worth using.

First off all, we must look at earnings growth. Now, obviously, there is no perfect correlation between a rising EPS and a rising stock price, but generally speaking, stocks with higher EPS growth outperform those with lower EPS growth over the long-term. When looking at the next five years, the sell-side is expecting Apple to expand its EPS by an average of 19-20% a year. This is below its five-year historical EPS growth rate (62.2%), but above what’s expected of Google (15.7%), Microsoft (9.8%), HP (2.2%), and IBM (9.9%).

When looking at just how the markets value this estimated growth, we can see a deep discount in Apple’s favor. Apple trades at a price-to-earnings growth ratio of 0.6, which is less than half that of Google (1.4), and below Microsoft (1.5), HP (1.3), and IBM (1.4).

Clearly, Apple is not the high-growth stock that we once knew. In comparison to the rest of its tech peers though, investors can get higher growth at a cheaper price, in addition to a dividend yield above 1.9%. Essentially, Apple investors can now get better income than a 10-year Treasury, with best-in-class earnings growth at a bargain bin price.

While we understand if you’d like to wait until the start of 2013 to get into AAPL – to wait out all of the near term profit-taking before tax hikes – this stock is one of the best (if not the best) tech companies for capital storage purposes. Assuming that you’re not overly bearish on the U.S. economy in general, and have a long-term time horizon, Apple is a great play. However, if you subscribe to technical theory, and are worried about McClellan’s comments over the short term, there may be better places to invest at the moment. 

This article is written by Jake Mann and edited by Meena Krishnamsetty. Meena has long positions in Apple, Google, and Microsoft.The Motley Fool owns shares of Apple, Google, International Business Machines, and Microsoft. Motley Fool newsletter services recommend Apple, Google, International Business Machines, and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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