Forget about fair value. Think about a price that will lead to profits with high certainty. On one hand the market is telling us, day in and day out, that Apple (AAPL) is not worth that much and on the other hand, analysts are telling us that:
- the projected value for Apple is $700, $800 or even more;
- Apple has a unique proposition;
- the pipeline is full of new amazing products;
- full monetization of existing customers is still to come;
- Apple sits on a cash pile of more than $130 billion.
No one is impressed by all that, anymore. The market is paying more attention to competition. New products are coming from Samsung, Nokia (NOK), Blackberry (RIMM), Google (GOOG)/ Motorola and others. Competitors are catching up by releasing products which are versatile and probably equally good.
More worryingly, the market perceives the iPhone and the iPad as commodity products; i.e. products that have lost their shine. I think that this is precisely the crux of the matter. Why pay more for something that, in relative terms, is similar to a cheaper product?
Fine. Apple is not worth $700 (note that back in September 2012 analysts and media were supporting the idea of Apple at $1,100!), but, then, is it worth $450? Is it worth more? Or is it worth less?
I will compare Apple with Microsoft (MSFT), Google, Amazon (AMZN), RIM and Procter & Gamble (PG). I do not suggest that Apple matches perfectly with any of these companies, but I do suggest that it shares some similarities with them.
- Leadership. At some point in time these companies held the title.
- Innovation. All of them have produced excellent, innovative, blockbuster products.
- Inherent value. There is no indication that any of these companies will diminish in value.
- Brand awareness. Unrivaled recognition.
- Global presence. Products that exist worldwide.
From this point of view, let me show you the numbers:
Market Cap ($Bl)
Profit Margin (ttm%)
Profit margin: Apple has the highest profit margin. It seems that the market ignores that. But why? I guess the expectation is that profit margin will go down due to extreme competition from other smartphone makers. This is a valid concern. A margin compression is very likely to occur.
P/E: Apple has the lowest ratio. The market expects that growth prospects will not be good. This is probably the reason for that. If we take into account the cash that Apple has, then the ratio goes down to c.7.
The analysis can go on, with the measures provided above (data source is Yahoo.com) or with additional measures, which are not provided here. I will not, however, expand further, since my thesis can be substantiated by the statistics provided hitherto.
I will use existing data and I will build a realistic price scenario that I believe is valid for the current quarter. This scenario is realistic assuming the following:
- Expected profit boost can come from services (iCloud Maps, iOS, iTunes) only.
- No new product(s) will be introduced during this quarter.
- New product(s) may be announced, but they will not be available within this quarter.
- P/E (c.10) remains constant.
- iPhone earnings contribution is c.50%.
Based on the above, I will develop a share price scenario with three pressure points:
- iPhone earnings go down 10%
- iPhone earnings go down 30%
- No earnings change, but product expectations are muted (5% down)
These pressure points (see table below) indicate that $370 is the lowest price projected price. This practically means that Apple's smartphone share will go down by a similar rate. This is pretty severe and unrealistic. A price of $420 is more likely to prevail since a 10% depression can be justified by aggressive profit margins offered (or likely to be offered) by Microsoft and RIM. A positive surprise would be a price of $430 and above.
Share Price ($)
iPhone 30% down
iPhone 10% down
I believe that potential investors should assume margin compression of 10% and should not pay more than $420, at this stage.
I believe, however, that this valuation should be revised to P/E c.10-12 and EPS to c.45-50 (price $450-$600) in the second quarter, due to:
- Announcement (or imminent introduction) of iPhone 5S.
- Announcement of a new derivative of iPhone (wider screen, lower price).
- Announcement of new derivative of iPad / iPod.
- ·Revamp of software offering (e.g. iCloud).
- Announcement of a brand new product (e.g. iTV).
In the medium run (2013), I expect Apple to introduce many new derivatives of existing products that will be better than the completion. Moreover, I anticipate Apple to surprise us with one or more new products. These moves will reduce the pressure on the share price, but may not push it back to $700.
In conclusion, I consider Apple a buy at $420 or below.