The recovery in Apple’s (AAPL) share price over the past year was well deserved but further gains could push the stock into overvalued territory, says Sam Peters, who runs the $2.8 billion Clearbridge Value Trust fund.
Last year, investors dumped Apple, sending the price below $60 (adjusted for the recent stock split), amid fears cheaper competitors would erode iPhone and iPad profits. But Apple’s profit margins have held up as consumers have proven their willingness to pay more for Apple's unique iOS software and vast app and media selections.
“They’re still sucking in incredible amounts economic value from the food chain of their ecosystem,” says Peters.
Instead, that fate has befallen makers of phones running Google’s (GOOGL) Android software. Shares of Sony (SNE) and Samsung Electronics (005930.KS) have slumped after both companies reported disappointing second quarter phone sales and falling profit margins.
Meanwhile, Apple’s rise, along with a few other savvy picks by Peters, has helped push the Clearbridge fund near the top of performance charts. With an average annual gain of 18.4% over the past three years, Clearbridge Value Trust has outperformed 94% of similar funds, according to Morningstar.
Apple was the fund’s top holding as of June 30, but further gains could prompt a reevaluation.
At current levels, Peters says the price is “fair” and assumes Apple will be able to maintain its profit margins, pay dividends and buy back more shares. But as the price rises above $100, giving Apple a market cap of more than $600 billion, the shares “become much less interesting,” Peters says.
That’s because even if new iPhones and other devices sell well, Apple will never be able to resume increasing its revenue and profits at the incredible rates seen a few years ago – it is simply too large now.
“That kind of growth is over – it’s just the law of large numbers,” says Peters.
A much smaller company could also be a big beneficiary of the next iPhone upgrade cycle, he says. NXP Semiconductors (NXPI) makes chips that Peters expects Apple will use in new models to allow for a secure, wireless payment feature.
With more than $5 billion of annual revenue next year, NXP will have enough resources to increase research and development and stay ahead of smaller competitors, which in turn should feed further sales. Peters calls it a “feedback loop on innovation.”
Peters joined Clearbridge parent Legg Mason in 2005 after managing funds at Fidelity Investments. He joined Value Trust as a co-manager in 2010, when Bill Miller was still leading the fund's investment team. Peters took over the reins when Miller retired in April, 2012, ending a 30-year run.
Microsoft (MSFT) is another top holding that has done well this year, thanks to the company’s increasing focus on the shift to cloud computing. Microsoft’s commercial cloud revenue is growing so rapidly it will exceed Salesforce.com’s (CRM) cloud revenue next year, Peters says. “They will have the biggest commercial cloud business,” he says.
Peters has succeeded by riding the recovery of some what he calls tech’s “dinosaurs,” including Microsoft, Cisco Systems (CSCO) and IBM (IBM), but he’s not interested in betting on a revival at Hewlett-Packard (HPQ).
The company has a more difficult financial position given substantial pension obligations, he says. “They grew up in the pension era,” Peters says. “We include all these kinds of things in the valuation.”
If he has any regrets, it may be selling Facebook (FB) too soon. Seeing the social networks potential to capture more advertising dollars, Peters rode the stock from the low 20s into the high 40s last year, when he sold. But he’s been impressed with the company’s continued evolution. And the stock is now into the 70s.
“Facebook has a shot at being one of the largest market cap companies in the world,” he says.