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Apple: Buy, Sell or Hold? Answer: Yes!

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Apple sees 3Q EPS $8.68 vs. est. $9.96. AAPL sees 3Q rev. $34b vs. est. $37.49b.

Those were a couple of the headlines flashing across the Bloomberg terminal late Tuesday afternoon. Now if Apple Computer were merely a mortal company without a history of under-promising and sensationally over-delivering, one would have expected investors to take the shares to the woodshed when trading resumed.

That was hardly the case as the stock rebounded from its recent correction by more than $50 on Wednesday morning as investors correctly focused on the phenomenal fiscal second quarter profit of $12.30 per share and revenue of $39.2 billion. Those figures blew away analyst EPS estimates of $10.02 on revenue of $36.9 billion, and represented gigantic increases from the $6.40 in per share earnings and $24.7 billion in revenue posted in the year-ago quarter.

Of course, Apple has always done a good job of managing Wall Street expectations. Indeed, here is what Steve Jobs had to say back in late 2002, “Looking forward, we do not expect our industry to pick up anytime soon, though we’re hoping to help put a lot of iPods, iMacs and iBooks under trees this holiday season. With the stability of our rock-solid balance sheet, Apple will continue to invest through this downturn to create the industry’s most innovative products and best buying experience.”

Apple’s legion of fans no doubt has grown exponentially since those dark days when the stock was featured as The Prudent Speculator’s December 2002 Stock of the Month at a split-adjusted $7.59 per share. Yours truly then wrote, “Obviously, we do not expect a return to the glory days of the late-1990s, but Apple’s financial condition looks remarkably similar today as it did back in 1997 when it made its initial appearance as Stock of the Month. That first recommendation resulted in a 500%+ average price appreciation when the last of our shares were sold in late-1999. Today, the balance-sheet is pristine with over $4 billion in cash and short-term investments, equivalent to more than $12 per share ($6 adjusted for the 2-for-1 split in February 2005). In 1997, Apple had $11 per share ($5.50 post-split) in cash on a virtually debt-free balance sheet.”

Not surprisingly, Apple holds a special place in my heart, as it’s the biggest winner (past performance is no guarantee of future returns) we’ve had in my quarter century with The Prudent Speculator. Click here for the entire performance history of all 1,760 stocks we’ve recommended since the inception of the newsletter in 1977.

Lest readers think that I’m penning this missive from my Larry Ellison/Russian Billionaire-like 450-foot yacht, I have to confess that I’ve sold a substantial chunk of my Apple holdings over the last nine years, the latest sale coming this March in the $583 range. In fact, in my own account, I now hold 9% of my original position, though believe it or not the stock is still my largest holding.

To be sure, Apple is hardly expensive on an earnings basis as it now trades for a trailing-12-month P/E ratio of 15. Also, the debt-free balance sheet contains more than $100 billion in cash and marketable securities and management just instituted a dividend payout that puts the yield not too far from what is presently being offered on the 10-year U.S. treasury.

Finally, the company has been growing like wildfire with the consensus fiscal 2012 (ends Sept. 2012) EPS estimate now standing at more than $45, up from $28 or so in fiscal 2011. All of this is why I continue to hold tight to the balance of my position.

On the other hand, the stock trades for a fairly rich 4 times sales and 5.5 times book value, visionary founder Steve Jobs is no longer with us and competition remains fierce. In addition, here lately, lawyers have been targeting Apple with antitrust charges and patent infringement claims, while labor practices at its contract manufacturer’s plants in China have created a public relations headache.

I might add that the law of large numbers is also a tough hurdle to overcome. Though Apple’s rabid customer base is about as loyal as they come, with a market capitalization approaching $600 billion, it becomes difficult to grow fast enough to retain the fickle fan base of investors on Main Street and Wall Street. That last constituency may be the most important as the fact that Apple now represents more than 4% of the S&P 500 means that professional investors are almost forced to hold the stock, lest they risk failing to keep up with the equity-manager benchmark. Incredibly, the weight of Apple in the index exceeds that of each of three of the ten S&P GICS sectors–Materials, Telecommunication Services and Utilities.

While one might think that mom and pop investors will remain true to Apple, especially as we have managed account clients who actually forbid us from selling their shares, hedge and mutual fund managers are not nearly as faithful. This is especially true these days with so many seeming to follow the herd as evidenced by the recent ‘risk-off’ double-digit percentage plunge in the stock from a closing high of $636.23 on April 9 to $560.28 on April 24.

So what’s an investor to do with AAPL today?

If you don’t own it, I’d wait for a drop closer to $500 before buying. If you do have it and you’ve owned it for more than a couple of months, I would opt for the middle way of locking in some profits by selling a little while leaving the rest to run on as my long-term target price is now $761.

To be more specific, as I believe in broad portfolio diversification, if Apple represented more than 3% of my equity holdings, I’d take some money off of the table, especially as there are plenty of other attractive names in the technology space into which I’d like to diversify.

Those favored names include fiber, cable and glass panel maker Corning (GLW), Swedish telecom equipment provider Ericsson (ERIC), video game publisher Activision (ATVI), microchip king Intel (INTC), software titan Microsoft (MSFT) and, for those who want a less well-known name, disk-drive component maker Xyratex (XRTX). Each is trading well below our determination of long-term fair value, while offering a solid dividend yield.

John Buckingham is chief investment officer of Al Frank Asset Management, Inc. (AFAM), an Investment Advisor registered with the Securities & Exchange Commission that edits The Prudent Speculator and is advisor to four proprietary mutual funds.

As advisor to its own proprietary mutual funds and manager of individual client accounts, AFAM may purchase, sell or hold positions in the securities that appear in this presentation. Also, AFAM employees may hold, purchase or sell any of the stocks that appear in this presentation subject to AFAM’s Code of Ethics, Insider Trading and Personal Trading policies.

Information provided comes from independent sources believed reliable, but accuracy is not guaranteed and has not been independently verified. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Past performance is not a guarantee of future results. Therefore, you should not assume that the future performance of any specific investment or investment strategy will be profitable or will be equal to corresponding past performance levels. Neither the information contained in this presentation, nor any opinion expressed, shall be construed to be or constitute an offer to sell or a solicitation of an offer to buy any securities.

Investing in stocks involves risk and possible loss.

If you would like to view a complete list of All Previously Recommended stocks, please see: http://www.theprudentspeculator.com/images/pdf/tps_prevrec.pdf.