About a year ago, I wrote an article about Apple (AAPL) joining the $500 Billion market cap club discussing where the previous members were at the time. A year ago, Apple could do no wrong and many pundits were assuring us that the stock would hit a trillion in market cap in no time. The point of the article was we have seen this movie before. The world is a competitive place and when a company is hitting on all cylinders with its innovative products; their competitors take notice and make adjustments. Today, Apple stock has dropped $200 a share and appears to be on the ropes because competitors such as Samsung (SSNLF.PK) have come out with new innovations of their own. Many are at lower price points. Apple could be forced to reduce profit margins in order to maintain and grow market share. Additionally, Apple products were previously reserved for only the coolest and hippest of our population. Now, the unthinkable has happened - many parents and even grandparents now own one or more of Apple's products. The hip first adopters now must now look outside the Apple family tree for their cool. Finally, those that were whipped into a feeding frenzy and purchased Apple stock at a much higher price a year ago are finding this Apple to be a sour one indeed. On its path to a trillion, Apple must first battle the immense overhead resistance of sellers that just want to get their original investment back.
Is the old Wall Street adage, "buy at the sound of cannons, sell at the sound of trumpets" appropriate in this case? The excitement of Apple certainly hit the crescendo at the peak price and the negativity seems pretty thick now, so perhaps a long position is the right move. The action in the stock around the $500 level has been impressive. A quick drop under that price seems to have woken up some buyers. Standard & Poor's recently reduced their one year price target to $665 which would be a return of over 30% from here. Apple bulls continue to view the stock as cheap based on the P/E of 11 which is much lower than most tech stocks and, indeed, the S&P 500. Apple's Return on Assets of 28.5% is among the highest among the "old guard" tech companies such as Microsoft (MSFT). Apple has some other great fundamentals such as zero long term debt, a well-publicized hoard of cash and a decent dividend that is easily supported. Perhaps the recent drop in share price will get management to do something more constructive with the cash such as a few acquisitions or an increased share buyback.
Almost any other stock with a forward PEG ratio of around 0.5 and a low P/E would be considered a good buy by most fundamental investors. It's difficult to say that Apple is currently priced for perfection, but perfection is what last year's investors expected, thus the parabolic run to $700. The slightest disappointment coupled with an increase in the capital gains tax has swung the pendulum in the other direction. While I thought the media buzz this time last year was overdone and a good signal to sell, the opposite is true today. When the financial news channels have a bug with a stock price in the corner because it is going up, it's time to take some profits. However, when the bug is there because the stock is tanking, it's time to take a look.
While I was skeptical about the trillion dollar Apple talk from last year, today I believe that the market has over-reacted to the downside. Yes the iPhone 5 was outshone by the Galaxy S and yes the iPad mini is missing expectations, but Apple still has a stunning product line, a top notch R&D program, and plenty of innovation left in the tank. Let me reiterate that they have a ton of cash to deploy towards any and every opportunity. Apple still has the best product success record in their class and they also seem to have the most loyal customer base in the world. Many of us that had zero Apple products just a few years ago now have several that are tied in together. This has created an intangible switching cost that means people like myself will not go through the hassle to change brands unless there is a big enough reason. While Android et. al. may very well be better is some respects, are those products so much better that so many new Apple users will jump ship? Will Apple let that happen without a fight? I doubt it. Finally, one of the reasons Apple is overvalued is the price of the shares. At $500, not everyone can buy a round lot. Something as simple as a stock split would be worth a nice move in the stock, in my opinion.
The point of my article last year was to be skeptical of a stock that everyone loves. Any negative comment regarding the stock was met with disdain. Today is quite the opposite and I now believe the stock can be considered here. Unlike many others, my intention is to write about Apple once a year, so feel free to check back next year when I write a piece about this article.
Richard Moore contributed to this article.
Disclosure: I am long AAPL.