"We still have a few surprises left for the remainder of this calendar year."
Those words alone have strategically carried AAPL shares since its mixed earnings release. We think it is going to take more prescient insight into the consumer electronics future and further amazing execution by the company's management team for Apple's pie, or its portion of the consumer electronics market share, to grow. Likewise, the value of its stock might seem attractive, but it incorporates these great expectations to some extent, setting it up for disappointment if it cannot deliver. What are you betting on?
Our founder earned clients a 23% average annual return over five years as a stock analyst on Wall Street. "The Greek" has written for institutional newsletters, Businessweek, Real Money, Seeking Alpha and others, while also appearing across TV and radio. While writing for Wall Street Greek, Mr. Kaminis presciently warned of the financial crisis.
Apple reported its fiscal fourth quarter results Monday night and they were stellar indeed. However, a great company does not always make for a great stock investment. I hear you! I hear you! Even while the shares were down Tuesday, they have gained 47% this year. I give you that, but Apple's time in the sun must come to an end (or at least slow up a bit), as it is governed by Moore's Law.
For those of you unaware, Moore's Law, strictly defined, governs the rate of change in the technological development in computer hardware and semiconductors. Generally speaking, new technology is rendered obsolete in a matter of a couple years, by the rule of law. Well, modern times and slang have stretched the law to cover the rate of innovation in all high technology.
Apple has proven a disruptive force under the leadership of its iconic CEO Steve Jobs. Upon his return to the company, Apple took right to turning the consumer electronics world upside down again. The iPod marked the first breakthrough of the AJ period (After Jobs' return). Apple became the driving force in the mobile music market (do you still own a Walkman?), and dominates MP3 player rivals like Sony (NYSE: SNE) and SanDisk (Nasdaq: SNDK) today. I mention SanDisk because I like their cheap basic player a ton (less than $50, but don't tell my girlfriend who got it for her birthday – let's see if she reads me).
Apple sold 9.05 million iPods in its fiscal quarter ended September 25, reported Monday night. But the trend in the iPod market foreshadows the future I see for Apple. While those sales were huge, they were down 11% from the year ago period. That's due to intensified competition from players like SanDisk.
The company was able to hand the baton of growth over though to another blockbuster breakthrough, the second of the AJ period, the iPhone. iPhone sales were up 91% this quarter (over prior year), to 14.1 million units. That is characteristic of the disruption Apple created in the mobile market, turning basic mobile phones obsolete (except for a shrinking segment of the marketplace – for low priced), killing Motorola's business (NYSE: MOT) and putting Nokia (NYSE: NOK) on the defensive. Apple also blew established smart phone players like Palm nearly out of business, before its rescue by Hewlett-Packard (NYSE: HPQ). Research in Motion (Nasdaq: RIMM), with its BlackBerry models, now sits behind Apple in smart phone sales. RIM sold 12.1 million phones (2 million less than Apple) in its most recent fiscal quarter, which the cocky Apple Inc. pointed out in its press release.
And not leaving good enough alone, the aggressive disruptor took on Amazon's (Nasdaq: AMZN) Kindle Book Reader (read us on the Kindle) in its third major move for the AJ period; this of course came with its introduction of the iPad computing tablet. Apple sold 4.19 million iPads in its fiscal fourth quarter. The iPad may also be putting coffee table books on the shelf as well, at least in Upper East Side dental offices.
Indeed, Apple's revenues soared 77% over the prior year quarter, to $20.343 billion. Its net profit rocketed 70%, and its diluted EPS climbed 67.5% (lower than profit on share dilution), to $4.64 a share. These do not only represent corporate records, but awesome growth due to the size of increase and given the absolute value of sales. Meanwhile, the company accomplished this growth while giving back ground in its profit margins. But this also hints at where I'm going with my argument, and my more critical than Wall Street's wondrous expectations for Apple.
Apple's iPad sales were a disappointment this quarter, believe it or not, as analysts were looking for 4.5 million unit sales or so. This sent the stock lower in the aftermarket Monday night, but only after recent weeks of skyrocketing above the $300 mark. Thus, even while it was down on Tuesday, investors who took first stake just a short time ago were still in the green. Analysts also have supported their own momentum based forecasts for Apple, and they will ride the stock until it crashes for the most part. Their higher ups are telling them not to fight the tide (trust me), and with bonus season near and job security slim on Wall Street, it does not pay to argue with your boss, for the sake of your pocket anyway (your soul's sake is another story).
The Future: A Rotting Apple?
Disruptive as it has been, and as cocky as it remains, Apple must continue to innovate in the amazing fashion it has in order for the company to continue to justify an above average industry valuation. Steve Jobs hinted at his expectation to do so in his statement we republished atop this article. He says Apple has more surprises in store for us this year. I think I know what Apple is working on, and if I'm right, he just might be ready to take the stock much higher. Still, unless Jobs has a standing deal in place with the devil, and even though he is by far the consumer genius of our times, the continuation of this epic tale gets harder and harder to extend with time.
As an analyst, I believed in incorporating this type of management value-add (in this case genius) into the valuation of a company and into the success rate expected from R&D spending, commensurate market share gains, and EPS growth. But there are limits, and Apple seems to be testing them. Some analysts seem to me inebriated by Apple's success and their own buy opinions. This and the market's chasing of the shares this week, offers clear cut sign of an inevitable and eventual disappointment. The higher you raise expectations, you see, the more difficult they become to achieve. Apple is approaching impossible levels, but it's not there just yet.
Apple's pie is being sliced up among its competitors, even as it takes from the whole. We have seen look-alikes pop up in each of its product segments, and while they may not all live up to Apple standards, they do find buyer interest at varying price points. As the competition gets closer to Apple, the pioneer is forced to reduce price, and thus the give backs in margins. The iPad might still be taking share from Amazon's Kindle, but at the same time, it is losing share to Dell and others. As the lives of Apple's products begin to resemble the iPod, the company (and stock) will come under increased pressure to reinvent the wheel again, and also reinvent another wheel. In other words, it must stay atop the markets it is currently shocking, and also enter new markets in disruptive fashion to keep growing at its fantastic pace and to maintain an above average valuation.
My hat is tipped to Apple's management team, though I do not own one Apple product (feel free to send me one to sample and review). Apple clearly is a cut above, as a company, but as a stock, today may not represent the most opportune time to take an interest. But that is not so clear either.
The iPod is maturing and the competition is catching up. The iPhone is cutting edge, but the gauntlet has been long thrown down, and the competition is impressive. Google (Nasdaq: GOOG) recently sold more units of its Android phones in a month than Apple sold iPhones. Finally, the latest product, the iPad, seems less disruptive than the others, and thus, looks destined to reign on top for a shorter span (more likely behind the Kindle), especially given product introductions by rivals Dell (Nasdaq: DELL) and Research in Motion (Nasdaq: RIMM). Though Steve Jobs got on Apple's conference call for the first time in two years, and said the rival products were too small. The fact that he even addressed them says something.
Apple's shares rose with purpose heading into the EPS release, and then sold off after it; a typical buy the rumor, sell the news scenario. The stock closed the day down 2.7%, but is in the hands of day traders now and is slightly higher a day later.
With its mix of businesses, Apple does not really have a pure peer; HP gets close though. Its P/E ratio of about 22X its trailing EPS does not seem too expensive when compared to historic growth, nor does it rate too high above analysts' forecast growth of 19% for the next few years. The tentative P/E ratio against FY 11 is 17.3, but that will likely move lower as analysts adjust forecasts to account for recent data. On a P/E basis, the stock is priced above Hewlett-Packard (NYSE: HPQ), Dell (Nasdaq: DELL), Microsoft (Nasdaq: MSFT), and Research in Motion (Nasdaq: RIMM). However, its expected growth rate justifies the valuation premium. The only question is, how reliable is the growth forecast?
While the stock appears to be worth buying today, much depends on its ability to continue to innovate. This is what justifies the elevated valuation, and the only dynamic factor that can sustain it. So, if you are buying Apple now, you are really banking on Steve Jobs and his team's ability to continue its streak of reinvention. Can Apple, now the second largest stock in the S&P 500 Index (behind Exxon Mobil (NYSE: XOM), based on market capitalization, stay on top of the stock market hill? History tells us that it's hard to stay on top.
"...if my intuition is correct, Apple may be about to bite into a new pie, where its disruptive ways could help its stellar growth continue and its stock price rise further as well."
Apple's special valuation has my attention but does not scare the hell out of me, despite the company's size and the difficulty to grow from such a heavy base point. My intuition tells me the stock could give back some ground in the near term, on the absence of news. However, I believe Jobs and his statement about another surprise coming, and if my intuition is correct, Apple may be about to bite into a new pie, where its disruptive ways could help its stellar growth continue and its stock price rise further as well. Thus, I would be looking to enter on weakness that might come on some macro factor, and I would use technical help to find that entry point. My untrained technical analyst's eye (I'm a fundamental analyst) tells me that is probably somewhere between $280 and $300, and I see a solid basement floor at $260. The stock trades today near $312.
I wonder if Jobs has a holiday season announcement planned for his latest invention, as the period is clearly key to any new product introduction. Maybe it will be the driver for 2011's EPS growth, but he stated the surprise would be announced in this calendar year. The one thing you can count on is that AAPL's near-term share performance will be tied to it and the rest of its pie eating as well.
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