Should Tim Cook Care About a 10% Stock Drop?

On Monday evening, Apple reported earnings and revenue that were above expectations. Sales of iPhones, however, were a little lower than predicted, and the company’s revenue forecasts struck some observers as underwhelming. In after-hours trading, the company’s share price fell 9% — representing $44 billion in lost market value. As I write this, on Thursday morning, the loss for the week is nearing 10%.

This kind of sharp price movement on seemingly modest news is not a new or isolated occurrence for Apple. Over the past 18 months the company’s stock price has careened from $705 (in Sept. 2012) to $385 (last April) — a difference of almost $300 billion in market capitalization — and back up to $555 before this latest earnings report. You can see what it is right this second, but last time I checked it was just below $500.

This volatility can’t be explained by actual changes in Apple’s earnings, which have been strong. And it seems too great to be explained by changes in the company’s earnings prospects either. If a company’s price/earnings ratio is very high (meaning that investors are counting on years of expected earnings growth) even slight shifts in its earnings trajectory should lead to big price moves. But Apple’s P/E is just 12, well below average for the S&P 500.

It sounds a little like a case of the “excess volatility” that Robert Shiller and others detected in stock prices back in the early 1980s, helping set off a long-running debate over market efficiency and rationality that was punctuated by the awarding of last year’s economics Nobel to Shiller, apparent counterpole Eugene Fama, and not-really-part-of-the-debate Lars Peter Hansen.

Shiller and his allies posit that this excess volatility is the product of investor error, herd behavior, feedback loops and the like. (My translation: People change their minds all the time about how much they’re willing to pay for stocks, because that’s just the nutty sorts we humans are.) Fama and his allies say nobody knows if the volatility is “excess,” and describe it as the product of something they call “time-varying expected returns.” (My translation: People change their minds all the time about how much they’re willing to pay for stocks, but that doesn’t necessarily mean they’re nutty.)

This debate, though, has really been about stocks in aggregate. Even Shiller seems to mostly agree with his teacher Paul Samuelson’s saying that the stock market is “micro efficient but macro inefficient.” To get at why Apple’s stock in particular has been on such a roller coaster, I think there’s a pretty simple explanation that incorporates both perspectives. Apple’s stock price isn’t excessively volatile; it’s necessarily volatile.

Apple’s string of product successes over the past decade has been so spectacular that there are few if any parallels in business past or present to compare it to. It is in a sector where seemingly healthy, hugely profitable corporations (Nokia, Blackberry) have been effectively wiped out within the space of a couple of years. And of course Steve Jobs, the crotchety business genius who co-founded the company in 1979 and drove its recent renaissance, died in 2011.

That is to say, the uncertainties about Apple’s future trajectory — even over just the next couple of years — are staggering. There’s no obvious Next Big Thing on the horizon for the company, but its last few Big Things (iPod/iTunes, iPhone, iPad) sure weren’t obvious beforehand either.

While it might be nice if the market could sift through all the possibilities and probabilities and calculate a reasonable average earnings forecast for Apple and an accompanying price, that isn’t how the stock market works. It is, to use Benjamin Graham and David Dodd’s famous formulation, “a voting machine rather than the weighing machine.” In this case, it’s also the scene of a fierce and long-running battle between Apple loyalists and skeptics, joined over the past couple of years by a few activist hedge fund managers badgering the company to give them more money. Also involved in the jostling are a lot of interested but not quite so committed investors trying to figure out which way Apple is headed, plus a bunch index funds that have to own a lot of AAPL because it has the highest market capitalization of any corporation on the planet (indexing giant Vanguard is Apple’s biggest shareholder).

So the price jumps around a lot, as one narrative or faction seizes the day and then another does. This isn’t a failure of markets. You could even describe it as a triumph of Bayesian decision analysis, as investors with very strong and very different prior beliefs recalculate the odds of Apple’s success as new information arrives. This process could even be delivering a pretty fair stock price, on average. Compared with archrival Google, where investors are quiescent and the stock price just keeps rising and rising, Apple may be less vulnerable at this point to sudden changes in market sentiment.

Still, even if Apple’s stock price on average makes sense, its week-to-week fluctuations are dizzying. Which raises the question of what if any heed CEO Tim Cook should pay that stock price. Apple’s darkest days, in the mid-to-late 1990s, were characterized by a misbegotten focus on maximizing shareholder value; Jobs, when he returned, was openly disdainful of the stock market and focused on coming up with dazzling products. Cook has shifted back in an ostensibly shareholder-friendlier direction, acceding to pressure to return more money via repurchases and dividends, although not returning quite as much as Carl Icahn wants.

Given how much money Apple has lying around — $158.8 billion in cash and marketable securities as of Dec. 31, according to this latest earnings report — it does seem like Cook has to do something with it. Even whopping increases in the company’s R&D budget, $4.5 billion in the last fiscal year, still wouldn’t make much of a dent. In an article in the December issue of Accounting Forum, economists William Lazonick, Maria Mazzucato, and Oner Tulum argue that U.S. taxpayers have done far more to enable Apple’s innovations — by funding research through DARPA, the Defense Advanced Research Projects Agency, in particular — than shareholders, who contributed around $100 million in the company’s early days but have since gotten that back many times over in buybacks and repurchases. I like the subversive tone of that argument, but I can’t really imagine Cook announcing a big voluntary payment to Washington anytime soon. I would like to imagine, though, that he sees the stock market’s uncertainty-fueled dickering about his company as permission to make his own danged decisions about its future, and not spend too much time worrying about what the market might be trying to tell him.

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