Introduction
This is (apparently) a success story. But it's more about luck than investment skills. It's the story of how I accidentally ended up with a 10-bagger in my portfolio.
Exactly eight years ago, in December 2013, I bought some Apple (AAPL, Financial) stock (it amounted to around 10% of my portfolio at that time) at around $72 per share. Adjusted for the recent four-for-one stock split, that is equivalent to a cost of $18 per share.
I never sold those shares (well, most of them), and they nicely compounded at a yearly rate of more than 30%. Even if this can sound amazing, the reality is that I did it by mistake. Calling such an outstanding investment result a mistake can sound quite odd, but that's what it is. My choices can in theory be considered impeccable, but the reasons that lead me to apply such a behavior were far away from being based on a well-thought investment process.
Before I delve into those reasons, and in order to explain what I think a sound investment framework should look like, I will refer to Terry Smith's well-known mantra:
1. Buy shares in good companies
2. Don't overpay
3. Do nothing
Only recently did I realize that I had unconsciously applied the above-mentioned investment principles, which is why I could reach such a surprisingly good result. Let's now analyze them one by one to see how I applied them and why.
Buy shares in good companies
Even if Apple was already an outstanding company eight years ago, I probably didn't really understand what a good company looked like back then and especially how good Apple was. As an engineer, I was heavily influenced by the technical aspects of the business (both as a user of their products and the knowledge acquired by working in this sector for many years), but I knew almost nothing about strategy and competitive advantages, so I was sort of half-blind.
As I today know, a company with a great product is not necessarily a great company. Technical competence and quality are paramount to capture your customers' interest (and Apple surely did it), but it is only when the value of your product/service becomes 'indispensable' for the customer that competitive advantages emerge, and there are only a few companies out there enjoying such moats that can consequently produce above-average profits for a very long time.
This means that a few years before, by following the same approach, I could have picked, for example, a company like Nokia, completely ignoring the fact that they not only possessed a tiny moat, but also that the moat was being rapidly eroded by competitors.
The high margins Apple enjoys today on their top-selling devices will come down eventually, but they are already delivering on what will provide profits and high margins for many years to come: their service business (App Store, iCloud, Apple Music, etc.). Service revenues were not significant a few years ago, but today they constitute around 22% of revenues (from the last quarter's results). That is what happens when you build a powerful ecosystem like Apple did: people won't easily jump to another one, they will stick to it.
Good companies, in Terry Smith's idea, are not the ones that are thriving today, but the ones that can continue to do so for many years to come.
Don't overpay
Back in 2013, saying that my valuation skills were poor would have been an understatement. I could barely look at the price-earnings ratio and a few other indicators to try to determine if a stock was undervalued or not. I was a "deep value" investor, but without really knowing what that actually meant. I could not run a discounted cash flow (DCF) model, let alone break down a business in its parts, analyze them and make future assumptions.
So I was, again, lucky to buy Apple mostly basing my "analysis" on the value of a few indicators. As you can see, the price-earnings ratio at the end of the 2013 fiscal year was 12 - it even looked too high to me at that time!
Today, Apple's price-earnings ratio is around 32. Is the company too expensive? The right answer is always: it depends. But for sure, Apple's multiple expansion is well deserved. The investing community now understands the company's potential, its competitive advantages and how hard it will be for its competitors to erode or destroy them.
The multiple expansion is only responsible for a 2.6 times price increase. The rest is due to Apple's earnings growth, as well as high ROIC and reinvestment rates and stock repurchases. If we add dividend returns (and growth), especially in the case an investor would have reinvested the dividends, the returns would have been even more compelling.
Do nothing
When I first bought Apple stock, I could not imagine that I would still hold it after eight years. My portfolio turnaround was quite high back then, so my investment horizon was way shorter than it is today. The only reason why I managed to hold on for such a long time was the incredible rate of stock repurchases (I have been joking with my wife that one day someone will take the company private and while scooping up the last remaining shares, will have to call me asking to sell them mine).
In 2013 alone, the company bought back the equivalent of $23 billon in stock (and, on average, it kept increasing that amount over time). Was this a good reason to hold on? Well, it was not enough. The investment landscape is full of companies squandering their hard-earned capital on stock repurchases in order to push up their stock prices (they want to gain investors' confidence and signal to the market that the stock price has a "floor").
But, as Warren Buffett (Trades, Portfolio) explained multiple times, "If you’re repurchasing shares above a rationally calculated intrinsic value, you are harming shareholders."
That was clearly not the case for Apple. But here's the issue: as I could not calculate Apple's intrinsic value (or better, a range of potential intrinsic values), I couldn't know if the company's stock repurchases were actually beneficial or not. I was just lucky to have Tim Cook and Luca Maestri invest that money for me for the last eight years; I could not hope for better capital allocators.
Conclusions
My Apple investment turned out to be very successful. We're not going to have more than a few 10-baggers in our investment life (in the best case). I bought a great company at a very good price and kept it in my portfolio for many years, but I did it for the wrong reasons.
We should learn from our mistakes, but we should not judge them from their outcomes. In some rare cases, we will get very good results starting from bad thinking. Our mistakes are not related to their consequences, as pure luck can can change the outcome and consequently hide them from our eyes.
My Apple investment has not been life-changing (it's still very interesting), but it made me realize the role of luck and how important it is to get our process right in the first place.
I am looking forward to my next 10-bagger: I will hopefully deserve it next time.
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