Anchoring on Apple's Price ($516) Will Hurt Your Returns

This article is part of our Rising Star Portfolios series.

Buying Apple (Nasdaq: AAPL  ) ? At over $500 per share? It's the most expensive the stock's ever been and it's the largest publicly traded company in the world. How can shares possibly go higher?

Well, that's what I thought ... back when the price was $430 ... and $465 ... and $480. I had first purchased a share of Apple for the Messed-Up Expectations portfolio at $328.62 last June. I had even convinced myself to buy again at a higher price -- $371.36 -- last August. But once the price got above $400, I decided to wait for the ever-famous "pullback" before increasing the portfolio's stake.

Boy, did I pay for that decision! If I had bought at $430, I'd be up 20%. Heck, a 7.6% gain from $480 in a couple of weeks is nothing to sneeze at. But I fell prey to that most insidious of all biases that hurts investors: anchoring. I had bought shares below $400 and I wanted to pay about the same price as before. So long, profits.

Yeah, I know. If I had bought at $480, the share price could easily have pulled back and I'd have a loss. But that's the point. We don't know the future. And I was willing to give up on profit -- I'm a long-term holder of good companies -- just because I was afraid of losing a little bit of money in the short term. Stupid! Especially when you add in that I've been the analyst following the company for the past four years for our flagship service, Motley Fool Stock Advisor.

So I know all about how Apple is battling Amazon.com (Nasdaq: AMZN  ) and Google's (Nasdaq: GOOG  ) Android in the tablet space, how it's jockeying against Nokia (NYSE: NOK  ) , Android, and Research in Motion (Nasdaq: RIMM  ) for smartphone domination. And that just doesn't matter. Apple's halo effect -- the act of buying a lower-end product like an iPhone leading to successive purchases up the food chain to iPads and iMacs -- is in full swing for the company. Here, take a look at this chart, showing the number of units of each product category:

Source: Company press releases. TTM = trailing 12 months.

The success of the iPhone has helped make the iPad a roaring success. And sales of both have helped increase sales of Apple's computers (CPUs). Plus, the rate of CPU sales has increased with introduction of the iPhone and, especially, the iPad.

What's next for the company? A new version of the iPad this year, probably some sort of television, maybe even some share repurchases or a dividend. None of those are reasons to hold back from purchasing the stock.

Plus, at last night's close, the priced-in expectation is that Apple will grow free cash flow by only 12% for the next five years, 6% for the following, and then stagnate to the end of time (discounting at my usual, and high, 15% rate). Really? For the past five years, it's grown FCF by over 60% annually. Even if it suddenly drops down to 20% a year for the next five years, shares would be worth almost $780, 50% higher than now. And given the trends shown in the chart, I don't think it's actually going to slow down anytime soon.

Anchoring. Bad juju for investment returns.

Come Monday, I'll buy more Apple for the Messed-Up Expectations port. Come and discuss this and other investments on my Messed-Up Expectations discussion board, or follow me on Twitter.

OK, maybe you're not convinced that buying Apple above $500 per share is the right move. In that case, take a look at this special report. In it, we reveal the name of the top stock for 2012, one you don't want to miss out on. Click here for your free report.

This article is part of our Rising Star Portfolios series, where we give some of our most promising stock analysts cold, hard cash to manage on the Fool's behalf. We'd like you to track our performance and benefit from these real-money, real-time free stock picks. See all of our Rising Star analysts (and their portfolios).

Fool analyst Jim Mueller owns shares of Apple and Amazon. He's an analyst for the Motley Fool Stock Advisor newsletter service.

The Motley Fool owns shares of Apple, Amazon, and Google. Motley Fool newsletter services have recommended buying shares of Amazon.com, Google, Apple, and Nokia; and creating a bull call spread position in Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool's disclosure policy is never messed up.


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  • Report this Comment On February 25, 2012, at 8:53 PM, neamakri wrote:

    Thank you for my new term "anchoring". You just pointed out a bias that I have, and will look to future purchases to eliminate this anchoring bias. I purchased (ARLP) at $53.30 and have been hoping it would drop to that again. Ha! Bad anchoring.

    From now on, each purchase will be judged on its own merits, not based on my past holdings.

    Thanks again, keep writing.

  • Report this Comment On February 25, 2012, at 9:10 PM, TMFBreakerRob wrote:

    Good article, Jim!

    We'll lure you to the Dark Side of Rule Breaking investing yet! ;) Seriously though, it's good that you've considered what kind of growth is priced in... compared that to how the company has been doing... and the likely future expansion as new products and new markets are penetrated.

    What should Apple be priced at? I won't try to claim any particular value, but it seems pretty clear that it should be quite a bit higher and future growth continues... and that's why it's 14%+ of my portfolio.

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