As I write this, Apple (AAPL) has declined to about $460, testing as low as $450 after a report that showed the company essentially meeting forecasts for the big Q1 quarter ending in December, but leading analysts to expect much weaker Q2 earnings and beyond. While I think AAPL is likely a decent purchase here and will share a few reasons below, the point I want to make today is that investors should see this decline as entirely rational. Let me explain.
AAPL has a long tendency of tracking its level of earnings:
The source of this data is Baseline, and the blue line represents the earnings (and projected earnings) with the price in yellow. It's pretty easy to see that EPS is highly correlated, not surprisingly, with the stock price.
What isn't entirely clear to the general public is that the expected earnings of AAPL are dramatically lower than previously expected. This information will become more readily apparent in the next few days. A great place for investors to see the trends in earnings estimates is on Yahoo Finance, but it isn't real-time. If you visit the site now, this is what you see:
Notice the "current estimate" - it's stale! While AAPL provided a sales estimate for Q2 (about 10% below prior expectations) and some guidance on gross margin (lower than analysts expected), it doesn't provide quarterly or even annual guidance for EPS. I have access to a few analyst reports and have checked the Internet to get a sense of what the "right" numbers are, and they are a lot lower. Here is what I have found:
- Baird: $40.91 for FY13 and $43.76 for FY14
- ISI $42.50 for FY13
- Nomura: $45.54 for FY13 and $49.69 for FY14
Unfortunately for those trying to decide what AAPL is actually worth, there isn't much discussion in the public domain on future earnings estimates, with, instead, a barrage of bottom-line conclusions like ratings and targets, which are not very meaningful to those who, like me, care more about the data behind these conclusions than the conclusions themselves.
There are about 40 analysts, so this sample is, unfortunately, rather small, but I think one can pretty easily conclude based on these three data points as well as observing the headlines regarding large target price reductions, that the estimates are dropping. I am assuming that the numbers will be something like $42 for FY13 and $46 for FY14.
As I demonstrated above, AAPL correlates well with earnings. While the PE fluctuates over time, I think that the trend in EPS has described very well the price action over the past year, including today's plunge. The chart below tracks the monthly close of AAPL with a rolling 18-month forward EPS. In other words, in September, at the peak, I was averaging the FY13 and FY14 estimates, which also peaked, while today, in January, I am using 1/6 of the FY 13 estimate and 5/6 FY14. Note that I have plugged in 42 and 46, resulting in a forward EPS of about $45:
From this chart, it's pretty clear that the weakness since September has been due to falling estimates. Just looking at the FY14 estimate, it peaked at $61.10 and dropped over the past four months to $56.40 going into the report. Now, it seems likely to be $46 or so.
So, for those not following all these numbers, it appears that AAPL's earnings growth is likely now to be negative for 2013 and up just slightly in FY2014 from the $44.15 it earned in FY12. This is dramatically different than the perception a few months ago and seems to explain fairly well the decline in AAPL over the past day and months.
I don't follow AAPL too closely, as I prefer to spend my time on stocks that are less widely followed. I last wrote about AAPL last March, when I shared four reasons to sell the stock and offered five potential replacements, in what proved to be a too-early assessment that investors should rotate out. Today, though, I find the stock to be interesting from the long perspective:
- It's cheap
- It's very oversold
- Two other technicals
Cheap isn't good enough, but it's a nice starting point. If the new consensus of modest growth is correct and my estimate of FY14 earnings of about $46 close to right, then 10PE before considering cash (over $100 per share) with a 2.3% dividend yield is fairly attractive.
I use an indicator developed by StockVal, and, at 450 this morning, the stock was almost 2 standard deviations from trend, a level of oversold that typically draws in price stability. Selling puts at that strike is a strategy that would make sense in my view. Speaking of options, the extraordinary open-interest in calls may be contributing to the excessive sell-off. Many individual investors have become comfortable owning in-the-money calls on AAPL over the years, as they don't want to pony up the full price.
Two other technical indicators would include the Fibonacci retracement from the low in the summer of 2011 to the September peak - 461 is the 61.8% retracement. It will be interesting to see if it holds that level on a closing basis. Most of today's volume has been pretty close to that level. The second thing that I would note is that we have now sold off 1/3 from the all-time high (470 is the exact price), a level that often proves to be a limit to a decline for a high-quality stock after a very long rally.
So, while I don't have a lot of conviction, I do think that AAPL's sell-off is likely near its end. More importantly, though, this isn't an irrational plunge but rather a move that makes sense. The old saying is "sell the rumor, buy the news" (or the opposite), and it applies well here. AAPL's large decline has been a function of the future estimates having been too high in 2012, and the news is now out.