- Michael Burry, head of Scion Asset Management, just reported a huge short position through put options in Apple (AAPL).
- This should wake up investors to potential issues with the stock, including its high valuation and market share issues.
- Investors should be careful with AAPL stock, especially if the U.S. consumer spending falls during a recession.
On May 16, Michael Burry, who runs Scion Asset Management, reported in a quarterly 13F filing that his firm has a huge short position in Apple (NASDAQ:AAPL). This was in the form of put options, his company’s largest holding, representing over 17.86% of total assets reported in the 13F filing. Assuming the firm is long those puts, the only way it is profitable is if AAPL stock falls a great deal over a relatively short period of time
In essence, he is making a massive short bet on the stock. Michael Burry is famous for being one of the main characters in the book and movie, The Big Short. So when he takes a large position like this, many people take a closer look at the stock.
The problem is we don’t know for sure when the big purchase of puts was made. We also don’t know what the strike price (exercise price) is, and how much he paid for the options. But one thing is clear. Since all options involve paying a premium, the stock has to fall below the strike price in order for the position to be profitable. Typically most put options involve strike prices within the next one to six months.
As a result, we should look carefully at what themes he might be thinking of, to invest against AAPL stock.
Possible Short Themes Against AAPL Stock
Recently a well-thought-out presentation was made on YouTube about Michael Burry’s short position against Apple stock. I am referring to the Unrivaled Investing YouTube channel. The channel suggests there are three potential reasons why Burry might be short AAPL stock.
The first is that the valuation of Apple stock has risen fairly high. It is now trading at almost a 24x forward price-to-earnings (P/E) multiple for the next 12 months (NTM). This reflects a major increase in its forward NTM P/E multiple over the past two years.
This can be seen in charts at Seeking Alpha and YCharts. They show that Apple’s P/E ratio three years ago in June 2019 was 15.9x and now the P/E is at 25x on a trailing 12-month (TTM) basis. The idea here is that Apple stock is trading at too high a valuation.
Another short theme is that it’s possible that Apple is starting to lose market share in its iPhone mobile phone sales compared to other major phone makers. Counterpoint Research shows that Apple’s U.S. smartphone market share fell from 56% in the fourth quarter 2021 to 50% in the first quarter of 2022. Moreover, Apple is reported to be having problems in its iPhone manufacturing operations and was cutting production at the end of March.
In its April 28 conference call, Apple said it would experience $4 to $8 billion “constraints” in its manufacturing and shipping operations. Apple also expects its gross margins to fall to between 42% to 43%. The gross margin was 43.7% in its latest quarter.
A possible third short theme is the decline in U.S. real disposable income in the past several quarters. The Federal Reserve Economic Data (FRED) site shows that monthly real (after inflation) disposable income has fallen 5.19% from April 2021 to March 2022. This indicates that inflation is taking a bite in consumers’ ability to spend money on things like smartphones. That is not good for Apple.
Where This Leaves Apple’s Stock Valuation
Here is a simple way to value AAPL stock and to see if its valuation is too high. In the last quarter, Apple produced $69.815 billion in free cash flow (FCF) in the last six months it made a 35.5% FCF margin. But in the latest quarter, its FCF margin was 26.6%. This can be seen in the Seeking Alpha financials tab where it shows the quarterly cash flows and capital expenditures (capex) spending. For example, it produced $25.652 billion in FCF from $97.278 billion in revenue.
As a result, if we apply this 26.6% margin against the $416 billion in revenue forecast for 2023, we get an FCF estimate of $109.4 billion. Next, if we say that this FCF represents a 5% return on its real value, the target market capitalization is $2,188 billion (i.e, $109.4b /0.05 = $2,188).
This is 4% below the present market cap of $2.279 billion, according to Yahoo Finance. But, if we apply this to the 2022 revenue forecast of $394.16 billion, the target market cap is $104.8 billion. That results in a target market of $2.096 trillion, which is 8% below today’s market cap.
In other words, assuming a 20x FCF multiple, AAPL stock could be worth between 4% to 8% less than today. But that also assumes its sales rise this year and next and the company does not feel the effects of a recession. That is not very likely.
As a result, investors might want to consider mimicking Michael Burry’s short position by buying puts in AAPL stock.
On the date of publication, Mark Hake did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.