As a follow-up to some of the comments on my past two articles and also, based on a reader's specific request, this article is about when to buy AAPL. My first article on Apple (AAPL) focused on the larger business eco-system that Apple is facing recently and questioned the possibility of even a modest margin compression due to various factors. The second article talked about how the recent inflection point about Samsung Galaxy SIII's sales leadership might play out within Apple's corporate discussions. There have been many good articles (both for and against) investing at sub-$600 price points in Apple. The concerns I voiced in my articles were the reasons I sold Apple in the mid $600's. Now, with Apple at least $100 cheaper than my exit point, I wanted to review if I should consider entry into this amazing company's stock again. With all this as context, let us examine two methods by which a possibly entry point can be established now for Apple. I will spare you the details of my Excel model but for those interested, I applied a probability-driven earnings growth model with some concession for projection error (in other words, added a 'margin of safety'). The salient results are presented under Method 1. In the second method, which is qualitative, I simply outline possible examples of change that potential investors should look out for, which would bode well for Apple in the future.
Method 1 (Quantitative): Valuation with 'margin of safety'
Before I present my results, many readers would recognize that there is at least one macro factor driving Apple's prices these days, which is unrelated to Apple itself. It is the potential for higher capital gains tax rate driving many to 'lock in' their profits at 2012 rates. While the number of large-stake investors selling for this reason is not fully known, it is reasonable to expect that this will exert some near-term downward pressure on all stocks like Apple that have allowed investors to achieve spectacular long-term gains. I believe this tax uncertainty will help in establishing an attractive entry opportunity for investors looking to enter (or re-enter) the AAPL journey from a long-term perspective. The publicly available information adapted in the table below is from Yahoo Finance.
P/E - trailing 12 months
Adjusted P/E (forward)*
Adjusted PEG ratio (forward)^^
$527.68(Nov. 16 close)
^ Price to Operating Cash Flow; *Considered until Sept. 2014 earnings projection with 15% allowance for negative surprise in earnings, compared to average analyst estimates; ^^Price to Earnings Growth ratio (over 5 year period), adjusted for a 30% lower earnings possibility than consensus average.
When the stock price reaches near $500, we will have a situation where even if there is a 15% negative surprise in next year's earnings, its P/E ratio will be about 10.1, i.e. a 10% earnings yield for the stock. For comparison purposes, S&P 500's forward P/E works to 13.9 (1360 Nov. 16 close for S&P 500/$97.87 forward GAAP earnings). You can use the ETF of S&P500 (SPY) as a proxy and arrive at similar figures. Even if I consider a significant earnings miss for the next year at Apple, buying the stock today at the low $500's can be a good entry point because it's forward P/E ratio allows it to be nearly 40% cheaper than S&P 500's forward P/E ratio (with no allowance for any earnings reduction). This can be considered as either today's 'margin of safety' or future 'room to grow' in the market's valuation of Apple. If the price declines below $500 to say, near $475, my model indicates a 'screaming buy'. Even if we assume that the various factors in its business eco-system cause Apple to miss its next 5 years of earnings growth by 30% compared to consensus (a rare event, I estimate very low probability for this to occur), its PEG ratio below 0.6 (at $475 price) should be treated as an exceptionally rare buying opportunity. That would truly be a 'fire sale' on AAPL.
Some may be wondering, what about buying at current price? That can be a good entry point too, but if you believe in holding for a decent upside from purchase price, buying closer to $500 gives a good margin of safety, given the business headwinds Apple still has to overcome. I don't place much faith in the $750-1000 target estimates that some analysts have, which require for their realization, an almost 'perfect' combination of favourable business and competitive factors, in my opinion. Instead, I seek a margin of safety at an entry point near $500, which can set one up for a conservative upside of 20-30% within the next 6-12 months, with mitigated risks to the downside.
Given the potentially higher rates of capital gains tax and dividend tax dominating the conversations around the so-called 'fiscal cliff', and given that we have nearly 6 weeks remaining before the end of this year, it may not be a bad idea to place buy orders around $500-510 limit. With the swings we are seeing, you might see your order filled before the year is out. Those wanting a more certain execution can set their buy limits closer to $520. Those wanting a higher margin of safety could consider a buy limit of $475 or so but there is some risk of your order not getting executed. Buying $600-650 call options for 6 month expiry or way out-of-the-money LEAPS at $700+ might also be interesting plays.
Method 2 (Qualitative): Material change in Apple's operating model and eco-system
This is another way of looking at 'margin of safety'. If we see notable, positive improvements in Apple's management actions or alternatively, see evidence of competitor snafus, such events provide a qualitative 'margin of safety' even at the recent closing price of $527.68. For example, Apple's settlement with HTC is a sign that Apple management is wisely considering commercial routes to monetization of its intellectual property rather than relying on protracted legal battles, with dragging appeals process and enforcement issues even after clear legal victories. Another example would be if Apple is able to successfully find alternate suppliers to Samsung for at least some of the critical components. Another event could be some hitherto undiscovered defect or issue with a leading Samsung or HTC product model. One sign could be a critical acquisition (at fair value or cheaper) that brings valuable new IP into Apple. Another one could be a major strategic alliance or a 'settlement' of some sort with all Android-based manufacturers with 'anti-cloning' provisions in key areas to help Apple retain the unique 'user experience' that Apple cites as its principal differentiator. These are examples of qualitative 'margin of safety' that an investor could see as supportive of an entry into Apple at the current price range.
Though it would be material, I am not including iPhone 5 supply chain resolution in this list because the market is eagerly waiting for it. So, it could be a market-moving event that I am not sure a small investor would be able to trade on. The downside risk is that such resolution may come after the demand 'normalizes' for iPhone 5, in which case, the impact may not be significant. Entering China, even if in a limited way, would be a strong sign, but could be market moving in a big way. These events could cause 'gap up' days in AAPL, especially if prices continued to remain in the low $500's.
In summary, buying close to $500 (or) buying at current prices with evidence of material change in Apple's business strategy to its evolving business eco-system could be attractive entry points for an investor with at least a one year holding horizon, providing a reasonable 'margin of safety'.