Why the law of large numbers doesn't apply to Apple

Covestor model: Macro Plus Fundamentals

Disclosure: This model is long Apple

We have come a long way from lows set in 2011. Job data continues to improve, and the European headlines continue to show commitment to a resolution. We cannot dismiss the fact that plenty of risk abounds to the recovery in Europe, but I believe the recent rally is warranted and the S&P still trades at a decent valuation to earnings.

Since there isn't much to report on the macro front I would like to focus on our investments and reflect on some of the decisions that were made earlier this year.

We went into greater detail on NetApp (NTAP), Qualcomm (QCOM), and Apple (APPL) a couple of months ago. I remain bullish on all these stocks and as of late February both QCOM and AAPL reported fantastic results. I want to focus on Apple.

After reporting blowout earnings the stock reacted positively, or did it? The company reported a more than 30% EPS beat, a 20% revenue beat, and record margins, and the stock was up 5%?! I was surprised by the reaction, and turned on CNBC to listen to the commentary.

I kept hearing about this law of large numbers, and even talk of buying on a dip. My interest was piqued. OK, so perhaps I am being sarcastic. What numbers are too large with respect to Apple? Revenue? Employees? Market saturation? Or is it simply the all mighty market cap.

Market valuation is one metric that has little bearing on the way a company manages its business. How many times do you hear analysts questioning a CEO on his or her market cap? The answer to that rhetorical question is almost never. So let us look at those other metrics more important to a company's growth and overall health.

I can see the law of large numbers applying to a company whose revenue is so large that it implies a logistical headache to keep the business efficient.

A similar thought process can be applied to a very large employee base. So how does Apple stack up to other large companies on these metrics? Well, Exxon Mobil (XON) generates three times as much in revenue, and UPS employs over 6 times the employees. That is quite a large distance from these other successful large businesses.

I would argue that neither of these factors is approaching a tipping point for Apple. That leaves us with market saturation. Companies like Wal Mart (WMT) struggle with this part of the law of large numbers, and I believe it is by far the best argument for the law in the first place.

Apple has not even scratched the enterprise surface, and still has plenty of business to steal from android in the phone business. Apple continues to create markets such as the tablet. With the likelihood of an Apple TV coming soon, more homes will enter the ecosystem providing new revenue opportunities in the content department.

Since the paltry 5% move after earnings the stock has tacked on another 10%, eclipsing $500 per share. The reaction was delayed, but the market finally priced in some of the spectacular beat. Future catalysts abound for Apple such as the company's decision to issue a dividend and buy back shares. I recently took a small profit in Apple, but it continues to be our largest holding.

Lastly I want to touch on the cash on hand. As of late February, we have approximately 20% of the model in cash. The model has performed very well this year despite not being fully invested. I believe that is a testament to being overweight the correct sectors and choosing the right companies. I remain constructive on the market in general, but a retracement would be healthy near term. I continue to look for other opportunities for the model, and have a couple of ideas I am doing more research on. Stay tuned.

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