***The following is excerpted from the “commentary” section of the February issue of Nate’s Notes, which was published for subscribers on 2/9/14.  All stock prices shown are as of that date.***

Is A Bad Apple Already Baked Into The Cake?

As Nate’s Notes enters its 20th year of existence, I want to once again thank all of my subscribers for your support over the years!  My goal has always been to help as many people as possible grow their nest eggs via a sensible, long-term approach to investing – including helping them navigate periods of volatility and uncertainty like the one we are in right now – and I couldn’t be more proud of the newsletter’s long-term record… thanks again!

Reflecting On Apple (AAPL – $519.68)

As those of you who are following the story already know, Apple’s stock gapped down roughly 50 points on huge volume following the release of the company’s most recent earnings report in late January, with the company’s “disappointing” iPhone numbers being cited as the primary reason behind the drop.

And, while the stock has managed to rebound a bit since then, a combination of the metrics in the earnings report and the “proof” of a declining stock price seems to have turned just about everyone and their dog into Apple bears.  To be sure, there is a very real possibility that they are on to something, and as much as I would like the great ride we’ve had with Apple over the past 16 years to continue, I have to admit there is a chance the magic really is gone after all.

However, I think it is also important to keep in mind that the premise behind virtually all of the bearish commentary is “there is no innovation going on at Apple”… and while this may eventually prove to be true, it is still only speculation.

Yes, it has been a long while since the company introduced something truly innovative vs. merely iterative, but assuming CEO Tim Cook is not bluffing (always a possibility!), I am willing to be patient awhile longer.

As an analyst on CNBC noted a few months ago, “Google (GOOG – $1,177.44) ships projects, Apple ships products”… and while this is not meant to be a knock on Google (a company which is currently firing on all cylinders – and admittedly puts out some pretty cool projects!), it is meant to drive home the point that unlike other companies (not necessarily Google) that rush to put products on the market simply to be there first, Apple has a long history of patiently refining its product offerings behind closed doors so that once they are finally released to the public, they usually stand head and shoulders above the competition.

I have no idea whether Apple’s next foray will be into TV, wearables, payment systems, or some other area, but what I do know is that at this point in time, with bearish sentiment so high, all of the bad news is probably already baked into the cake, and consequently, any good news will force a very large number of analysts and investors to rethink their numbers going forward.

Getting more specific, if a great new product fails to materialize and the company does slowly lose clout in all the areas in which it competes, it seems reasonable to me to assume the stock could slide back down to the $400 level (or so) over the next 12 months.  However, if it turns out there is a rabbit sitting in Tim Cook’s hat just waiting to be pulled out, a $700 share price is not at all out of the question as a realistic price target… and given how pessimistic everyone is these days, I think that if the stock does manage to get back to all-time high territory, it will likely overshoot that $700 mark by another 30%-50% (“trends often go on for longer than seems reasonable,” right?) – and this, in turn, means we would be looking at a share price somewhere in the $900-$1,000 range.

To be sure, given how big Apple already is, the stock is not likely to do more than double (or maybe triple, if we get into a really crazy bull market) for us at this stage of the company’s evolution… but I believe it represents exactly the sort of conservative investment that deserves a large position weighting in the portfolio of anyone who is attempting to build wealth over the long-haul.

With the upside potential being 4-5 times larger than the likely risk to the downside, I would take that bet even if there was only a 50-50 chance of it paying off.  However, in this case, I think the odds are actually more like 80-20 in our favor (admittedly based on the assumption that Tim Cook is not bluffing about “great stuff in the pipeline”), and thus I am completely comfortable adding to our Apple position at this stage of the game.

That being said, I am being fairly aggressive about adding shares to our already large positions with the following two caveats – 1) if the stock fails to hold the lows that were set a few weeks ago, we will likely take some chips off the table, and, perhaps more importantly, 2) in order to make sure we don’t get stuck in a game of perpetual waiting, if we still do not have any clarity six months from now (when the August issue goes to press) regarding the great new stuff that’s supposedly on the way, we will rethink our position (i.e. it is a pre-determined deadline designed to take the emotion out of our decision-making process, similar to what we do with our eyebrow levels).

And, speaking of stocks with upsides that are significantly larger than their downsides, I am once again going out of my way (briefly, as promised last month!) to draw your attention to MannKind (MNKD – $5.39), as I really do believe it is a stock that holds far more upside potential than it is currently being given credit for… and that spells opportunity!

However, I want to remind you that, unlike the story at Apple (which will play out based on how millions of people around the globe respond to the company’s product line-up), the story at MannKind is a bit less straightforward in that it hinges on the company first receiving approval from the FDA for Afrezza (always a crapshoot, no matter what logic says the odds should be heading into a meeting), and then, assuming approval is granted, whether or not the masses do, in fact, adopt the company’s product over existing ones to treat their diabetes.

Consequently, this stock only deserves an oversized weighting in your portfolio if you’re willing to absorb any losses that may develop if the FDA does not rule in our favor come April.  

As it stands, I am leaving things as they are in the Model Portfolio (designed for more conservative investors), but am using some of our gains in Illumina to increase the size of our MannKind position by a full third in the aptly named Aggressive Portfolio this month… and, depending what is going on with the overall market next month, we might even do something similar again in the March issue if the stock is still trading in the $5-range a month from now, as I believe the current price represents a very steep discount to what the stock will be worth if things do fall in our favor.

Finally, in an attempt to also add a little more commentary than space constraints allow later on the newsletter, I want to talk a bit about one of our other stocks that is currently sitting at the other end of the “waiting” spectrum in terms of rewarding us for our patience.

As I hope you’ve noticed, Illumina’s stock (ILMN – $156.90) has been on fire lately… and, while it is hard to consider the stock cheap at this stage of the game, there is no doubt that the company is executing better than just about anyone else in the markets in which it competes.  This fact, combined with the observation that the stock is currently in a very strong uptrend, suggests that there is probably a lot more room for it to run on the upside (provided the market as a whole does not break down anytime soon).

That being said, thanks to the great run the stock has made over the past twelve months, Illumina is now the largest position in both of our Portfolios by a pretty wide margin… and consequently, I am taking advantage of the situation to sell a sizable chunk of our positions in order to redistribute that capital across a number of our other stocks that are still on the runway waiting for take-off, so to speak.

However, please note that even though I am taking a fair number of chips off the table when it comes to Illumina, it in no way represents a change of heart regarding the company’s long-term potential. In fact, with it becoming more clear with every passing quarter that the company’s management team is running circles around just about everyone else in the industry, it is a stock that you should try to hold on to as much of as you can while still sleeping comfortably at night.

***the following are excerpted from the “company write-ups” section of the same issue***

Apple

For the company’s first quarter, Apple reported revenues of $57.6 billion and net income of $13.1 billion, or $14.50 per share, as compared to revenues of $54.5 billion and net income of $13.1 billion, or $13.81 per share, in the same period last year.  As discussed above, I continue to believe that the best thing we can do at this stage of the game is to be patient and let the very smart people who are running the company do their thing.  The company took advantage of the recent overreaction to buy back $14 billion worth of stock, and along those lines, you are encouraged to vote against Carl Icahn’s share buyback proposal.  Especially for more conservative investors, AAPL is a strong buy under $500 and a buy under $550.

Illumina

As we postulated might happen in last month’s issue, Illumina’s stock has done its part to validate the notion that “strength often begets strength” when it comes to trends in stock prices!  The catalyst for the move was yet another great earnings report from the company, with Illumina reporting fourth quarter revenues of $387 million and net income of $81 million, or $0.56 per share, as compared to revenues of $309 million and net income of $72 million, or $0.53 per share in the same period last year.  With the stock now accounting for roughly 14% of both Portfolios, I am locking in some profits and redeploying the capital across several other positions this month.  ILMN is now a strong buy under $125 and a buy under $150.

MannKind

MannKind is also discussed a bit above, but I don’t mind reiterating here that I believe this is a stock that the bears may have gotten in over their heads on, probably based on the assumption that “since Exubera was a flop, Afrezza will be too…” However, I want to point out (yet again) that there are numerous differences between the drugs (some of them quite dramatic – to the point that even mentioning them in the same sentence is actually kinda silly).  A gamble? Most definitely. Fairly favorable odds?  Yes.  An above-average payoff if we’re right?  Absolutely!  What more can I say?!  Provided you are not yet overextended in terms of portfolio allocation, MNKD is considered a strong buy under $6 and a buy under $8.