It was Thanksgiving weekend twenty years ago. I had been watching the stock for a couple of months. It was pummeled on soft results in September and seemed cheap to me. On Sunday night, I looked at the Value Line report and on Monday I reviewed the latest financial statements. On Tuesday morning, I pulled the trigger. I was now the proud owner of 500 shares of Apple purchased at $18.1
Hindsight bias is pernicious. By perceiving past events as more predictable than they actually were at the time, we mentally torture ourselves regarding outcomes that could not have been foreseen. Even worse, when we believe that we had foresight in the past that we did not really have, we are more prone to be overconfident regarding current events. This can lead to underestimating the vicissitudes in life that could upend the future.
This article is a true story of a trade nearly two decades ago that seemed smart at the time but, in hindsight, carried a severe opportunity cost. Was the decision a good one based on the information then at my disposal? Or was it a foreseeable debacle that should have been avoided?
Flashback to 2000
Let’s take a journey back two decades to the fall of 2000. By the end of September, the Nasdaq composite index was well into bear market territory, having fallen nearly 30 percent from its high in early March, but the worst was yet to come. Back then, Apple was a struggling computer maker that had suffered greatly in recent years and found itself on the verge of bankruptcy before its iconic founder, Steve Jobs, returned to engineer a turnaround.
When you read about the turnaround today or look at a 20 year chart of the stock, the turmoil of late September 2000 will hardly be noticeable. But the company was having problems that fall and did not sell as many computers during the key back-to-school season as analysts had expected. When the company warned that sales were soft ahead of the end of the fiscal year, the stock was pummeled, falling over 50 percent on September 29.
I started watching the stock.
I cannot reconstruct the story exactly. I did not keep any type of journal in 2000. I was not very experienced when it came to investing nor did I have much capital to invest. But for some reason, Apple’s sharp drop in September caught my attention and I began to follow the company. It is likely that I pulled up the Value Line report on Apple and I’m sure that I also read its latest 10-K and quarterly report, but I doubt I did much more than that. However, by November, I was ready to act.
The Trade
Following its earnings warning at the end of September, Apple continued to fall for the next couple of months. By the end of November it was trading around $18 which must have seemed attractive to me based on the numbers published in the company’s latest 10-K. The company seemed to be on the right track and was trading under ten times trailing earnings:
In addition to being cheap on an earnings multiple basis, the company had book value of over $12 per share and had over $4 billion in cash and short term investments on the balance sheet. The market capitalization was around $6 billion. The market reaction must have seemed overdone to me and the cheapness of the stock suggested a margin of safety. It would be nice to believe that I developed an investment thesis more complete than what I just described but I doubt that was the case.
On Tuesday, November 28, 2000, I purchased 500 shares of Apple at 18 1/16 for a total cost of $9,051.25, including a $20 commission. On March 5, 2001, I sold the 500 shares for $20.25 for proceeds of $10,105 after another $20 commission. My short term capital gain was $1,053.75.
The chart below shows the price action for Apple stock from July 1, 2000 to June 30, 2001 along with my trades:
This capital gain of slightly over a thousand dollars represented a 11.6 percent gain in just over three months, or an annualized gain of over 50 percent. But it wasn’t smooth sailing during those three months. The stock bottomed at $14 in December and I was substantially underwater before realizing the gain in March.
What was my rationale for selling?
I can only guess.
I suspect that I was attracted by the round number of the $1,000 capital gain. A thousand dollars remains a lot of money in absolute terms, in my view, and certainly back then it was very meaningful. I had made this money in a short period of time and probably wanted to take it off the table.
What did I do with the proceeds?
On this question, I can reconstruct the events with more certainty. The first purchase I made after selling Apple on March 5 was a purchase of 5 shares of Berkshire Hathaway Class B on March 16 at $2,145 per share.2 It so happens that I still own those shares of Berkshire today.
The Aftermath
We all know the story of Apple since I sold in 2001. In the fall of that year, Steve Jobs unveiled the first iPod music player followed by the first iPhone six years later. Today, Apple is a behemoth – the largest company in the United States with a market capitalization in excess of $1.4 trillion.
If you calculate what I left on the table by taking the current stock price of around $317, subtracting $20.25 and multiplying by 500, you would get a figure slightly under $150,000. That’s a lot of money to leave on the table!
But it is worse than that.
Much, much worse!
Apple shares split 2-for-1 in 2005 and split again 7-for-1 in 2014. This means that the 500 shares I sold in early 2001 would be the equivalent of 7,000 shares today. If you take $317 and subtract $1.446 ($20.25 divided by 14) and multiply by 7,000, you get a horrifying $2,209,000!
But wait, there’s more!
Apple started paying a dividend in 2012 and has paid a total of $16.87 per share of dividends over the past seven years. Take $16.87 and multiply by 7,000 to arrive at an additional $118,000 opportunity cost!
But let’s look on the bright side. I still own the shares of Berkshire purchased with the proceeds of my Apple sale. Those five shares of Berkshire Class B have become 250 shares due to Berkshire’s 2010 stock split and are now valued at about $57,000. This represents a compounded annual return of 9.3 percent over the past nineteen years. Not too bad, right?
Evaluating Decisions
Was my decision to trade Apple a mistake? Should I have held those shares purchased in November 2000? Based on what we know today, the answer is self-evident. With benefit of today’s information, it was insane to sell those shares in March 2001!
The problem is that there was no crystal ball in March 2001 that could have predicted the company’s meteoric rise. I could not have predicted it and neither could anyone else. Apple had not even released the first iPod at that point. There was no iOS ecosystem to lock in consumers. It was a struggling personal computer maker in the early years of a turnaround engineered by a visionary but highly erratic leader. It was extremely cheap, however, and had a margin of safety.
Arguably, the stock continued to have a margin of safety when I sold it and there is little doubt that I had a “trading mindset” at that time, at least when it came to Apple. My profits reached a round number and I cashed in my chips and used the proceeds to invest in something I understood well for the long run. Buying Berkshire, in contrast to Apple, was intended to be a multi-year commitment and it turned into a multi-decade commitment — one that I understood well.
Psychological Perils
No matter how much we learn about human psychology, we must never, for a second, pretend that we are studying the mentality and behavior of others. We are, in fact, studying ourselves because we are just as subject to all of the pitfalls as anyone else. Understanding human psychology helps us to understand ourselves better but never immunizes against second guessing and regret. Until recently, I never calculated the opportunity cost of selling those shares. I obviously knew that I had owned Apple years ago and sometimes it occurred to me that those shares would be worth a fortune if I had held. But I avoided the calculation until recently when I posted the results on Twitter:
It turns out that personal humiliation will result in many retweets and likes, but in reality, is there much of a reason to feel humiliated? Not really. After all, little known Apple co-founder Ronald Wayne sold his 10 percent stake in Apple way back in 1977 for a mere $800. Today, this stake would be worth about $140 billion. Mr. Wayne is 85 years old today. Maybe he dwells on the idea that he could be the richest American alive today, but hopefully not. There is no way anyone could have predicted the rise of Apple over the past 43 years.
The endowment effect is just as pernicious as hindsight bias when it comes to investing. If I had just considered trading Apple back then but never actually owned shares, I would not give my “mistake” even a passing thought today. It is the fact that I did own those shares and then decided to sell them that makes it an issue. For some reason, it is not similarly problematic to know that I missed out on other meteoric success stories such as Amazon or Netflix. I never understood either and certainly never owned shares.
Even if I had held those Apple shares beyond March 2001, I know that I would never have continued to hold them until today. For better or worse, I have long been a skeptic regarding Apple knowing that the past is littered with examples of consumer electronics firms that have fallen out of favor. I would have doubtlessly taken money off the table during the early years of Apple’s ascent to reduce risk exposure. The only way I would have held those shares without interruption would be if I had fallen into a coma.
In contrast, I have held shares of Berkshire for multiple decades and I have other investments that I have held for very long periods of time as well. In all of these cases, I had a firm understanding of the businesses involved and a sense of their futures. That was never the case with Apple.
The Headline Was Click-Bait …
So, was this a $2 million “mistake”? I don’t think so. The $2 million in “lost profits” represent a fictional illusion, no more real than if I had won a lottery. But hopefully this story sheds some light on the nature of decision making and the importance of not falling victim to hindsight bias when evaluating past decisions.
Disclosure: Individuals associated with the Rational Walk LLC own shares of Berkshire Hathaway which has an equity ownership interest in Apple.
- My purchase was 500 shares at 18 1/16. Stocks were still traded in fractions back then. This is the equivalent of 7000 shares of Apple at $1.29 per share after accounting for a 2:1 stock split on 2/28/2005 and a 7:1 stock split on 6/9/2014. [↩]
- This is the equivalent of 250 shares at $42.90 based on Berkshire’s 50:1 stock split on 1/21/2010. [↩]