AAPL: problems of size

the behemoth

APPL shares now make up about 5% of the capitalization of the S&P 500.  A single share of AAPL sells for over $600.  Both characteristics present headwinds for AAPL’s performance, in my view.  The latter is a minor one, the former somewhat more serious.

Let’s start with the stock price.

the round lot syndrome

Individual investors in the US prefer to buy shares in round lots, normally 100 shares.  A generation ago, when the commission on odd lots (anything less than a round lot) was higher than for round lots, this made a modicum of sense.  Not so now, when flat $7 or $8 commissions are the norm for any number of shares bought or sold through discount brokers.

Professional investors, who think in terms of dollar amount rather than share count, don’t have this hangup.

Nevertheless, the psychological allure to individuals of buying 100 shares remains, as well as the stigma attached to purchasing 8 or 27 or some other “strange” amount.  And the reality is that AAPL has to a large extent been driven by individuals.  For investors unwilling to commit $60,000+ to one stock, then, AAPL shares are priced out of their reach.

a stock split?

There’s a simple, practical solution to this issue.  AAPL could have a stock split, something it did in 1987, 2000 and 2005.

My guess is that a 2:1 or 3:1 (or 10:1) split would add 10% to the stock price.

Why?  The shares would be more affordable to individuals with the round lot mentality.  In addition, the company would be signaling that it cares about its shareholders.

Why is AAPL hesitating?  Who knows.  My take is that management wants to be seen as obsessively focused on creating new products, not on catering to the whims of Wall Street.

professional investors’ position sizes

Growth investors in the US typically hold 50 or so stocks in their portfolios.  Their value counterparts usually have at least 100.  This means that for a professional growth investor, holding a S&P 500 index weighting in APPL requires making the position 2.5x the size he’s accustomed do.  For a value investor, a market weight for AAPL in the portfolio is a whopping 5x his average position size.

To be sure, all professionals have overweights–positions whose portfolio size exceeds the benchmark index weighting.  But these are usually a 3% or 4% position for growth investors, and 1.5% or 2% positions for value investors.

For almost everyone a 5% position is off-the-charts risky.  It’s conceptually very easy to underweight the name, but very hard to overweight it.

not a problem outside the US

Investors in non-US markets don’t have this psychological/operational problem.  Most other markets have at least one giant corporation whose weight can easily be 10% of the index.  Many times, it’s higher.

In most cases, the very large company is also very mature and slow-growing.   A typical strategy is to “neutralize” or equal-weight the stock in the portfolio (so that nothing the stock does will either harm of benefit the portfolio vs. the index) and attempt to make money elsewhere.

I suspect this is the tack US professionals are increasingly taking toward AAPL–equal-weight and forget.

the 5% rule

The 5% rule is an SEC-mandated diversification requirement for equity mutual funds.  It has two provisions:

1.  A manager can’t make a purchase of a stock that would cause the position size to exceed 5% of the fund assets.  This is only about buying.  There’s no need to reduce the position if it goes up a lot or if other positions shrink (which could happen either all by themselves or from the manager selling).  You just can’t add to a 5% position.

2. 25% of the portfolio is exempted from this requirement.  This exception is big enough to drive an 18-wheeler through.  The manager can basically do anything he wants in one-quarter of the portfolio, but is bound by the 5% rule for the rest.

Psychological issues aside, this should leave lots of room for mutual fund managers to hold a ton of AAPL. While that’s true, the other side of the coin is that the SEC has in effect linked prudent investing with having positions that are 5% of assets or smaller.  Bigger is bad.  Plus, the actual 5% rule sounds weird and is hard to explain.

The result has been that the idea of having no positions bigger than 5% has leaked into fund operating and monitoring procedures.  It’s also become part of the descriptions of investment process given to potential investors.  And it’s also in contracts with institutional investors (I don’t know how widely, though).  So the manager may be buying a lot of headaches if he continues to grow his AAPL position.

to sum up

AAPL can fix the round lot issue.

On the position size score, old habits die hard.  The 5% size is institutionalized as a maximum.  No one wants to rewrite contracts, primarily for fear the client will also want to rewrite the fee structure downward.

I don’t think any of this means AAPL will necessarily be a bad stock, either.  But I do think we’re at the point where the tailwind of professional investors having to build AAPL positions or else underperform is changing into a headwind caused by the stock’s large size.

There’s stuff AAPL can do to address this issue, too, but let’s see a stock split before taking up that topic.

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