By Philip Elmer-DeWitt
April 16, 2012

Why would a stock like Apple fall 10% just before quarterly earnings are due? 


MONDAY 4:00 p.m. UPDATE: Throw another -4.15% on the barbie. One analyst called today’s selloff “panic profit taking.”

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I think it may be time once again to dust off Jason Schwarz’ classic blog post: Apple: Seven Reasons Shorts Love It.

Apple’s (AAPL) shares, in case you missed it, took a drubbing last week, falling $38.77 (6%) in four days — from Tuesday’s all-time intraday high of $644 to Friday’s close at $605.23.

[They fell another 3% in early trading Monday and closed at $580.13, down $25.10 (4.15%) for the day and 9.9% from last week’s high.]

To be sure, there was a bit of negative news that could have triggered some selling. The Justice Department’s antitrust division sued Apple and five publishers last Tuesday for alleged collusion in the e-book trade.

But that doesn’t really justify knocking $36 billion off Apple’s market cap [minus another $23.4 billion Monday morning]. Sales of e-books amount to a tiny fraction of a revenue rivulet (“Other music related products and services”) that including iTunes music sales represented just 4.4% of Apple’s total revenue last quarter.

And the stock, as any technical trader will tell you, was overbought and ripe for some profit taking.

But even the technicals have their eye on the next major event in the Apple news cycle: The company’s second fiscal quarter earnings, due out a week from Tuesday.

Past performance is no guarantee of anything, of course, but it’s worth noting that Apple’s shares rose 8.29% in 2011 the day after Q2 earnings were released. In 2010, they soared 14.63%. In fact, as Bullish Cross‘ Andy Zaky points out, Apple’s shares have climbed the day after the Q2 report every year for the past six, rising an average of 3.67%.

This is where Jason Schwarz comes in. I’ll post a summary of his seven reasons below the fold, but the meat of his argument can be summarized in two sentences:

“If you can keep a good stock down then you are able to load up for the ride back up. It’s like a slingshot — the harder you pull, the more propulsion you generate.”

Apple’s Q2 earnings will be released after the markets close on April 24. A conference call with analysts will be webcast here.

Below: Schwartz’ seven reasons.

You can read the full text of his thesis here. If you don’t want to click through The Street’s version — posted in seven slow-loading gallery pages — you can read the executive summary we published in 2009. Except for some of the pre-iPad details and the last point, about Steve Jobs, it rings as true today as it did three years ago.

1. Apple is the market leader. This one stock has become so important to the market that its action is contagious. This influence makes Apple a prized possession for both the longs and the shorts. Knocking down an easier target like Research In Motion

or Citigroup

doesn’t generate the same snowball effect.

2. Apple always bounces back. Over the long run, Apple fundamentals will certainly take the stock higher, but hedge funds want to maximize the ride. Keeping a great stock down allows them to profit from quick predetermined trades rather than being fully invested all the time.

3. The predictability of Apple reduces a short’s risk. Everyone knows when the next iPod, iPhone,and iMac refreshes will hit. This has turned into a calendar-driven catalyst stock. During the quiet time, the stock is vulnerable.

4. New media have changed the game. Anybody can say anything and the masses will believe it. The topic of Apple currently dominates this new media. There is no accountability or verification of sources like the old days. In such an environment, hidden agendas can be pushed endlessly without disclosure.

5. Apple secrecy. As the unparalleled leader in tech innovation, Apple feels that it is necessary to keep future products veiled to all competitors, consumers and investors … Apple has yet to sell a single Tablet, yet hedge funds already have made millions from rumors surrounding the product. The lack of transparency from Apple creates a perfect storm for short-term traders.

6. Apple innovation. This company is so good that it causes imaginations to run wild. A hedge fund could float a story that Apple is thinking of buying Saturn in order to develop a new brand of Apple cars and people would go nuts … The constant innovation coming out of Apple provides traders with endless material for believable speculation.

7. Steve Jobs is the visionary of the century. This one man is the single greatest asset in corporate America, which causes Apple stock to trade with a Steve Jobs premium, a variable that the shorts can use as well. Apple’s stock is always vulnerable to losing Jobs. [Note to Jason: Please recast this item.]

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