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What To Do With Apple?

This article is more than 10 years old.

After Apple reported earnings, I asked Kai Petainen, one of the Warren Buffetts Next Door, and Eugene Groysman, the Marketocracy Master who has made the most money on Apple, whether they would put new money into the stock at today’s prices. Eugene is a former Washington, DC lobbyist whose skill at reading the political landscape has proved to be an increasingly valuable investment advantage as the government has taken over more and more of the economy.

Ken:  There are 2 analysts calling for Apple to break $1000. What do you think of that price target?

Kai: I can understand how they got it, but I don't like how they got it. The dividend discount model in Bloomberg has AAPL above $1,000 but that model makes a critical mistake, in that it assumes that Apple will grow 20% for the long-term. Use that same model and change the assumed terminal growth to 5% (close to the GDP’s growth rate) then you get $250. So it's quite possible that those who are predicting $1,000 and those who are predicting $250 are using the same model, but assuming different rates of long-term growth.

Ken:  What do you think is the “right” growth rate?

Kai: Apple amazes me. Its earnings went from $3.33 per share two years ago to $6.40 last year to $12.30 this year.  I would never make a valuation model that predicts that kind of growth.  It seems outrageous, but Apple did it.

Eugene: I think 20% is too high, but 5% is too low. I would look at some where in the 10-12%. I am calling for Apple to make a run to $800 by the end of Q3 before it stalls.

Kai: $800 is close to what I think.  As I see it, if funds have 4% (of their assets) in Apple, then it can still grow 25% before it bumps up against the 5% threshhold which most funds won’t want to cross. Take the current price, multiply by 25% and that gives you $750, so I have an upper bound of $750.

Ken: What did you pay for Apple and when?

Eugene: I bought it 7 years ago at 38. I originally put 4% of my portfolio into it and it has grown to be close to 25%.

Kai: I remember Eugene talking about Apple years ago. I was just arrogant enough not to listen.

Ken: Eugene, your Apple investment has increased 15x in 7 years, what do you do now? If you had new money to invest, would you put it in Apple at today’s price or something else?

Eugene: I would put new money into American Capital Agency Corp. (Nasdaq:AGNC) and Annaly Capital Management, Inc (NYSE:NLY)

Ken: What do they do?

Eugene: Both companies capitalize on the interest rate spread. They invest in residential mortgage pass-through securities and collateralized mortgage obligations for which the principal and interest payments are guaranteed by a U.S. Government agency or U.S. Government-sponsored entity. They fund their investments primarily through short-term borrowings structured as repurchase agreements.

Ken: How leveraged are they?

Eugene: AGNC’s debt to equity ratio is 7.9 and NLY’s is a bit lower at 6.9 AGNC has a 2.3% rate spread and NLY is at 2.1%.

Ken: With that much short-term debt, you really have to make a strong case that interest rates are going to be flat to pound the table hard for these stocks.

Eugene: I don't see any political or economic reason that in the next two years short-term interest rates will rise. The Fed has said they won’t be raising rates until sometime in 2014. Furthermore, in this election cycle the big issue is jobs, and neither side actually has a real answer for it. They will try to create jobs, but fail, which will keep the Fed from raising rates, and keep these two companies making money.

Ken: Eugene, as a former Washington, DC lobbyist, you are able to assess the political factors of an investment decision better than most of us. Tell me more about the political factors you see affecting interest rates.

Eugene: You have to keep in mind that a politician’s first priority is to be reelected, and that people who are unemployed are motivated to vote against incumbents. Because the REAL jobless rate is over 12% and all the government spending to create jobs has been ineffective, I believe the Fed is under tremendous political pressure to keep rates right where they are.

Ken: No matter which party wins the election, they will want to keep rates low?

Eugene: Right, no incumbent, from either political party, wants to raise interest rates because that will increase unemployment and put their own jobs at risk.

Ken: Volcker did it when Reagan was President, so it could happen.

Eugene: Right, but under Volcker, there were not as many people with upside down mortgages. We are in a different world today.  If Volcker were in office today, I don’t think he would raise rates as he did under Reagan because there are just too many people who would lose their homes. If you are unemployed AND living on the street, you are really going to be motivated to vote against the incumbents.

Ken: What would you look for in politics to tell you when to get out of these names?

Eugene: That job creation is off the main table. It would signal that Washington is happy with the current level of job growth. As long as the Fed keeps rates where they are, the banks will make out like gang busters by borrowing money from the Fed at near zero, and lending between 2%-3.5%.

Ken: Why are these companies a better investment than the banks?

Eugene: The dividends. The banks have to get the government’s approval to pay dividends. These companies don’t. In fact, both of these companies have elected to be taxed as REITs under the Internal Revenue Code of 1986. As a REIT, the company would not be subject to federal income tax, provided it distributes at least 90% of its taxable income to its shareholders.

Ken: What is the dividend yield?

Eugene: 16.6% for AGNC 13.8% for NLY.

Ken: Those are impressive yields. These companies have done well as interest rates fell. Since rates don't have much farther to fall, does that mean the shares don't have any potential for appreciation?

Eugene: If you assume for AGNC a 8x multiple, and a conservative EPS of 4.70 for 2013, it could hit $38 or about 25% increase

Ken: Would you be willing to sell a little of your Apple to buy these names?

Eugene: Yes.

Thanks Eugene.

You can view Eugene's top 5 holdings, learn more about his strategy, and track his progress with monthly Performance Insights emailed directly to you at the end of each month.

The Marketocracy team will be speaking about their investment strategies at the 2012 Money Show in Las Vegas on May 15th.  Visit us online at Marketocracy.com and register to meet Eugene, Kai PetainenTim EriksenRandy McDuff, and the rest of our all star investors.

For additional investment insight, you can follow the Marketocracy Masters and the WarrenBuffetts Next Door by signing up for our free email list.

Disclosure: I am the portfolio manager for mutual and hedge funds advised by Marketocracy Capital Management, an SEC registered investment advisor. Before relying on the opinions expressed in this article, you should assume that Marketocracy, its affiliates, clients, and I have material financial interests in these stocks and may hold or trade them contrary to these opinions when, in our view, market conditions chang