Thu, 22 Sep 2011
Research Affiliates' Rob Arnott thinks it is unlikely Apple deserves it's place as the largest market-capitalization company in the country and that investors shouldn't expect outsized returns.
Burns: Speaking of things people love, and this is kind of from the outside, I was looking at Apple the other day. It's been years since I looked at Apple, and when I took over the exchange-traded fund team, I kind of stopped looking at individual stocks a little bit. I could see, it was $400 now. I think the last time I looked it was like $120, and people were arguing over, "Well is that too much?" But even at $400, you have company like Apple trading at a forward P/E of 12 times. Where does that fit in the Research Affiliates Fundamental Index? You see that huge growth. How does a firm like that fit in the fundamental indexing story?
Arnott: Firstly, the forward P/E is something that's used on Wall Street very aggressively because it leads to lower P/E number, because the E is bigger. The E is bigger because it's a forecast. I think forward P/Es are a terrible way to choose investments because they make the assumption that a forecast is reality. Backward-looking P/Es or, better still, P/Es based on smooth multiple-year earnings I think make a lot more sense. On that basis, Apple is pretty darn expensive.
It's also priced to be the largest market-capitalization company on the planet. Now what that means is that, the markets are telling us this company will produce bigger profit distributions to its shareholders than any other company in the world. Is that possible? Yes. Is that likely? My guess is probably not.
Arnott: If it happens and it is the biggest source of profits on the planet, all that does is justify the current price; that doesn't say it's cheap. So, I view that as a vivid example of the merits of RAFI. RAFI takes these companies that are trading at lofty premiums and says, "OK, that's already in the price." If it's in the price, that means forward-looking returns would be market returns. And so let's take that for granted and just reweight it down to its economic footprint.
Take out-of-favor companies, BofA is a beautiful example, and say this is wildly out-of-favor, people hate it, fear it, and price it to reflect that expectation. But it's in the price. And if it is in the price, the forward-looking return is the same as Apple's, which means why not reweight it to its economic footprint?
It doesn't mean that Apple's going to perform worse as a business than BofA, and it doesn't mean that BofA is immune to catastrophic outcomes. It just means that in terms of rebalancing, you're using the price movement of these companies as a basis to rebalance against the market's most extreme bets.
Burns: Who knew that consistently selling high and buying low is a good way to beat the market.
Arnott: It does tend to work for the long-term investor, not every month, not every quarter, not even every year, but over time it does tend to work.
Burns: Well, Rob, I want to congratulate you and your colleagues at Research Affiliates. A lot of the debate that's been happening between fundamental indexing and cap-weighted indexing was kind of happening in that theoretical...
Arnott: You guys hosted the first debate, that was me and Gus Sauter in '05. That was such fun.
Burns: But, eventually, just like sports pundits and people putting teams on paper, eventually, you have to get on the field and play the game.
Arnott: That's right.
Burns: Five years, five stars later, so congratulations to you and your team.
Arnott: Thank you.
Burns: Thanks for joining me.
Arnott: Thank you. Appreciate it.