After Apple Corrects, Look for Real Market Leadership

Hilary Kramer

Hilary Kramer is an investment analyst and portfolio manager with 30 years of experience on Wall Street.

With the biggest stock on Wall Street down more than 10 percent in five weeks, it is time investors cut through the chatter and face a few simple facts.

It’s getting icy out there. Out of the 5,000 stocks I track, 3,000 are already in formal bear market mode, down 20 percent or more from their peaks. That includes 35 percent of the S&P 500 and four members of the elite Dow industrials.

With so much of the market’s weight already below the bear line, it’s going to be a whole lot harder for the stocks in the remaining pockets of strength to keep the indices aloft.

Apple (NASDAQ:AAPL) provided a lot of that strength. We spent weeks waiting for its earnings to reassure investors unnerved by the guidance we’ve gotten from smaller companies. But now it’s hard to fight the conclusion that growth is getting a lot harder for this corporate giant to sustain.

I’ve watched the comparisons get harder and the margins get thinner here year after year. Now it’s time to look a little lower on the market food chain for more dynamic business models that can create the giants of tomorrow — and not simply make yesterday’s success stories a little bigger.

And it’s not just Apple. Four of the five biggest Silicon Valley heavyweights have now stumbled within the last two quarters. They’re 10 percent of the entire market between them. When they trip, all of Wall Street reels.

That’s why my subscribers only buy these companies as short-term swing trades via the Turbo Trader system, where the right few months in Amazon (NASDAQ:AMZN) can generate most of the sweetest returns of a buy-and-hold approach in a fraction of the time or risk.

And in my options-driven High Octane Trader, a 2 percent shudder on Alphabet (NASDAQ:GOOGL) or even Microsoft (NASDAQ:MSFT) has turned into double-digit-percentage profits in a matter of days.

But we’ve otherwise steered clear of these companies. The clock was ticking. My longer-term portfolios were built around more sustainable stories.

What’s Wrong with Apple

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Apple is still a magnificent enterprise. At this stage in its evolution, 1 percentage point of sales growth is practically $3 billion, which is enough to buy a few small-cap technology companies outright.

The problem isn’t keeping the Apple faithful inside the platform paying service fees and upgrading their devices every couple of years. The problem is that truly compelling new products to sell them are scarce and take time to ramp up.

Take the Apple Watch, the closest thing to a really hot new concept Apple has come up with in years. Talking to industry experts, my best guess on sales here is $5.6 billion a year, roughly 35 percent of the company’s “Other Products” business segment.

A hungry rival like Fitbit (NYSE:FIT) or even Garmin (NASDAQ:GRMN) would do cartwheels to sell that many devices. For Apple, it’s only a small cog in a vast machine.

Doubling the Apple Watch market would only boost overall Apple sales 6 percent in a given year. After that, it gets harder and harder to push the growth needle. Meanwhile older products fade from the mix. The iPad, for example, desperately needs to be refreshed or retired.

As for the iPhone itself, unit sales have stalled. If not for the soaring price point on the most advanced models, there’d be no real growth to work with here. One day we’ll find out what the Apple faithful consider too high a price to pay for a phone.

In the meantime, management isn’t going to report unit sales on iPhones and other Apple products any more. That’s an ominous sign.

They track these numbers internally. There’s no reason to take them away from us unless they’re deteriorating or at best reveal some unflattering truth about the company’s pivot to India and other emerging markets where the long-term growth is.

Add it all up and I wasn’t shocked at all to see that Apple barely expects to generate $3 billion more revenue in the current holiday season than it did last year. Half of that growth will probably come from services and the other half is all about the Apple Watch. All other devices have hit a wall.

For the full year, I don’t believe the company can grow services and launch new products fast enough to cover erosion from the older devices. At best I see 5 percent sales growth ahead. That’s not a boom. It barely supports a pulse of profit expansion.

Pockets of Real Strength

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It’s definitely not the dynamic profile that draws investors to technology companies. And as Apple slows, its massive footprint becomes a drag on the market as a whole.

Consider: this single company accounted for 4 percent of all revenue growth on the S&P 500 on a dollar basis this year. Next year, that contribution gets cut in half. When Apple slows, Wall Street as a whole needs to work that much harder to compensate.

Fund managers who’ve been content to buy and hold Apple forever now need to find a way to remain competitive. That means chasing smaller stocks where every percentage point of growth doesn’t require quite so many billions of dollars.

I’m keeping my eye on PayPal (NASDAQ:PYPL), where revenue is still ramping up three times as fast as it is at Apple and margins are robust enough that every dollar on the top line turns into a lot of profit.

Even Visa (NYSE:V) is growing twice as fast as Apple. There’s a reason the payment stocks have held up a lot better than the technology giants: they’re actually more vibrant businesses at this turn of the economic cycle.

Look to Expedia (NASDAQ:EXPE) for a company using the economic cycle to refresh faltering margins and reinflate the fundamentals. Here, too, sales are growing twice as fast as at Apple, and the stock is rallying for a reason.

Media. Car parts. Big Pharma. Payroll processing. Medical devices. This is where the real fire is in the S&P 500 right now. They’re the ones I screen for inclusion in my Value Authority and GameChangers lists.

These stocks may not be able to compensate for the hole a slowing Apple leaves behind. But investors who focus on this end of the market and ignore the index won’t feel much drag.

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