Apple's (AAPL) drop may be unjustified, but the reality is that it is happening and it is happening on strong volume. The question on how low Apple can go is an important question not only to speculators but for investors looking to seize the opportunity for long term plays. Simply buying a stock because it has gone through a significant drop is not a good reason to go long without looking at some value prospects.
The bubble is clearly popping for Apple, there is no doubt. But Apple remains strong fundamentally, which means there is a good chance it could appreciate in the future after the stock price has corrected. If you're a value investor you might be looking for a good discount level to get in at, but what would that level be?
Historically, long term trends usually retrace to levels of 2/3, 1/2, and 1/3 respectively. I assume for the sake of analysis that this very long trend started around 2004 where their price was around $7.
What is important about these levels is not only their technical significance but how the levels will affect their Price / Book (P/B) which is one of the most important numbers to a value investor.
Price/Book & Tech Companies
Tech companies usually float above their base line P/B for significant amounts of time, such as IBM (IBM), and this can make value propositions more difficult. The easiest way to think of it is like this, if oranges are worth $5 but they have been selling for $10 for the last 10 years, $8 would be a discount.
Since mid 2009, Apple has kept a some what solid P/B in the range of 5 to 5.5. With its recent drop in the last several months, it is now trading at a discount. It is impossible to know how deep the discount will go but by looking at other stocks in similar spaces we may be able to get some insight.
The aforementioned companies actually share an interesting characteristic that is different than AAPL. Since 2009 the P/B levels of this group have been dropping. It is actually not a big surprise that Apple's price is dropping, its P/B is meeting up with the rest of the group. However, Apple is in the best economic shape compared to the group with more money in the bank. It stands to reason that Apple, which has historically had a more stable P/B, would become a value play if it were to drop to P/B levels that were below the group.
How Low Can Apple Go?
If Apple continues to retrace to a level of 1/2 (it has already broken the 1/3 mark) this would make their P/B value roughly 2.6. Is 2.6 a reasonable discount for a company like Apple? Let's take a look.
|Ticker||Price / Book|
The 2/3 retracement level would put Apple at a 1.73 P/B, this would be a severe discount to even Dell. I can't imagine them dropping to a level that is so far below Dell's P/B with their current fundamentals, so it is more likely that the retracement will continue to a level of 1/2 or $351.
There is an important issue that should be considered and that is while AAPL's price drops its book value will continue to climb. What this means is that its value proposition will be accelerated.
|Dec. 31, 2012||127.35B|
|Sept. 30, 2012||118.21B|
|June 30, 2012||111.75B|
|March 31, 2012||102.50B|
Apple's book value increased by 7% in Q4 and if we assume that this growth rate is maintained for Q1 2013, we can apply this forward to the previous level mentioned of $351.
If its book value is going to increase to 136.26B for Q1, that would mean the P/B for Apple trading at $351 would actually be 2.4. If the decline continues for the next two quarters, a level of $351 would give a P/B of 2.24. At 2.24 Apple would be trading at a discount to dell and I think most value investors would see this as a pretty big opportunity.
There is always the chance Apple could tumble to its 2/3 level, but I think this is some what unlikely unless there is a turn in the overall market.
If you're a value investor looking at a long term play, Apple might be a good choice but just not yet. Based on Apple's peers, a P/B of less then 3 would be good and a P/B of less then or equal to 2.5 would be even better.