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VOL. 127 | NO. 80 | Tuesday, April 24, 2012

David Waddell

Avoid Too Many Apples in Your Portfolio Diet

By David Waddell

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Apples to Oranges Investors and media have run out of superlatives to describe Apple Inc. Not only has Apple become the biggest investment story, it has also become the world’s most highly valued company. Today Apple represents 4.4 percent of the S&P 500 and 16 percent of the Nasdaq composite index.

For investment managers building fresh portfolios today the first investment question they must answer is “How heavily should I weight Apple in the portfolio?” Owning it marks them safely to the heard, not owning it subjects them to substantial benchmark risk should Apple account for moves higher in the indices. This benchmark incentive to own Apple simply multiplies its ubiquity. Growth managers advocate its growth rate; value managers advocate its valuation. Everyone likes Apple. Should you like oranges?

Morningstar classifies Apple as a large cap (cap = size) U.S. growth stock and Apple’s strength has translated into strength for the category. Over the past year, Apple has appreciated 67 percent, large cap U.S. growth stocks have appreciated 8 percent while the S&P 500 appreciated 5 percent. Conversely, the foreign small cap index, a suitable antonym, lost 14 percent over that time period. Global small caps are the orange to the Apple.

With the proliferation of capitalism globally, few investment opportunities hold as much promise as global small cap companies. Yet, according to Morningstar, while there are 2,092 large company U.S. growth funds there are less than 25 global small company growth funds. This overstocked lake is vastly under-fished. Furthermore, with ETF’s and program trading driving correlations ever higher in widely held securities, the volatility risks associated with small cap stocks have infected large cap stocks as well. The popularity and relative outperformance of large U.S. stocks has also pushed relative valuations to extremes. The U.S. stock market now trades at a 43 percent premium to its international peers.

As confidence grows, U.S. popularity may diminish as money migrates to the unloved and undervalued global corners in search of greenfield return opportunities. Furthermore, tight central banks in the emerging markets have begun easing, adding stimulus into the system that will begin to appear later in the year. With international valuations low, sentiment sour and central banks easing, offshore opportunities abound. Remember, this says nothing of timing.

In the short term the market is a voting machine, in the long term it is a weighing machine. At the moment, with Europe fragile and global growth in question, the Apples get all the votes, but this just makes the oranges juicier. After feasting on Apples consider adding some oranges to your diet.

David Waddell, who is regularly featured in the Wall Street Journal, USA Today and Forbes, as well as on Fox Business News and CNBC, is president and CEO of Memphis-based Waddell & Associates.

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