The biggest question in technology stocks this year has been when shares of Apple (NASDAQ:AAPL) will find a bottom. The stock has languished, and that might be an understatement. It has been more like a fall from grace.
Just six months ago, times were great for AAPL; outlook was fantastic, analysts were projecting incredible price targets upwards of $1,500 per share, the stock was reaching highs of over $700, and nothing could go wrong. Then came the reversal, and it wasn't dramatic. A 5% correction followed by a $30 trading range and another dip. All of a sudden, six months later, the bottom has fallen out, bears have taken ownership of the stock price, continued earnings growth has somehow been parlayed into end-of-the-world fright, and the stock has tumbled 39.5%.
There is no end in sight. Nobody wants to own AAPL now. That means it is time to buy.
An Overdramatic Run for the Hills
When AAPL reported Q1 2013 earnings (we'll talk about these earnings shortly, which happened to look pretty solid) on January 24, 2013, the stock lost $60 billion in market capitalization in a single day. Further, since reaching those aforementioned highs in September of last year, the company has lost $263 billion in market cap. To put that in perspective, there are only 3 companies in the S&P 500 that even have market caps over $263 billion - Exxon Mobil Corp. (NYSE:XOM), AAPL, and Google (NASDAQ:GOOG). After analyzing the earnings numbers for Q1 and the growth/value forecast for the coming years - keeping in mind that AAPL is still regarded as the most highly-respected brand in the world - and taking the precipitous fall from grace in perspective, it is up to you as an investor to determine if AAPL is a good investment.
Continued Growth - Top and Bottom Line Command
AAPL has grown at an incredible rate for the past few years, both as a company and in the value of its shares. It has defined the term "growth stock" for the past decade. If you invested money ten years ago in AAPL, you would have made 65x your investment by now (at current depressed levels). If you invested money five years ago, you would have quadrupled your investment. The growth story is still intact - an investment that quadruples in four years is very attractive - but it has decelerated from the days of the initial iPod launch. There is less room for AAPL to grow, but a much, much greater marketplace for it to exist (and thrive!).
When we analyze the revenue numbers in the chart above, which was part of AAPL's 10Q released on January 24, we see growth occurring where it matters most - geographically in China and the Americas; product growth seen in the iPhone and iPad. From a geographical perspective, the most growth needs to happen in the greater China region (Mainland, Hong Kong, Taiwan) because of the sheer size (and growth) of the market. When a company expands market share in an already expanding market, the results are exponential. The Chinese mobile market is dominated by Android-powered smartphones and tablets. There's significant room for large-number growth here. More on that later.
From a product perspective, the Mac (both stationary and mobile) and the iPod are dying breeds. The future is in mobile - both smartphones and tablets (iPhones and iPads) - and AAPL is continuing to forge its way as a design innovator and brand leader in both of these categories. The company sees increased pressure from GOOG and Microsoft (NASDAQ:MSFT)-powered mobile devices. From a hardware perspective, it's battling Samsung (OTC:SSNLF) and Nokia (NYSE:NOK) for mobile dominance. The real answer is, though, that all three are winning because of the continued growing market. The fact that AAPL saw quarterly average revenue growth of 26.3% in its top two product categories which account for 76% of overall revenue is a telling sign that the business performance is outpacing stock price.
On the bottom line, AAPL continues to see increased profitability, and will continue that growth trend through 2015, at which point, the slowing growth is forecast to turn into value preservation. Below are consensus analyst forecasts for earnings through 2016.
As noted, the growth story is still there! Heading into 2014 and 2015 analysts are predicting continued 13.5% and 10.5% growth, respectively. Since when does that story (along with strong unit sales and growth in the major revenue-driving product categories) trigger a $263 billion sell-off? Therein lies the divergence.
New Market Potential - Lower Margins; Huge Velocity
Analysts have bemoaned the idea of a lower-margin iPhone for the Chinese market, citing the fact that lower margins are always the first step to a company losing its identity. It should be noted that AAPL must not lose its identity now, but it is certainly time to change. As we saw above, the shift is coming from a tremendous growth story to a value play. With that shift comes a few significant changes:
- The institution of a dividend
- Preservation of market share (in a still-growing market)
For a technology company like AAPL, it also demands that R&D not suffer - that new markets be explored and seized if the overall benefit to the company outweighs the negative impact that the financial engineers will see in promoting their profitability % and gross margins. While margins are key to a business' performance, a small decrease (as forecasted) will be made up in sheer numbers of further penetration into the Chinese market.
Valuation Play - AAPL is Cheap!
I don't know where AAPL will bottom out. It might continue on this trend to $350 or we may have seen the bottom here today at $425. Nobody is sure of that. What I am sure of is the fact that AAPL is desperately cheap on a valuation basis. As noted, sizeable growth is forecast for the next two years through 2015. Discounting that growth, AAPL is trading at a trailing P/E of 9.64x. This is a company that has over $100 billion in the bank for its dispersing pleasure (after 60% of it is taxed from off-shore holdings, of course), continued strong growth for the next two years, a portfolio of products that rivals its competitors, and one of the top teams in the world to continue making AAPL strong. The Computer Hardware industry has an average P/E of 14.2x and the Technology sector as a whole trades at an average P/E of 19.4x. AAPL - the most admired brand in the world - is trading at less than half of that valuation.
The divergence is apparent here - the AAPL sell-off from its September highs, while somewhat warranted, has gone too far, too fast. To reiterate, since reaching those highs, AAPL has shed more than the value of Wal-Mart (NYSE:WMT) in market capitalization, or $263 billion. The stock was overextended at those $700 levels, and the analysts who predicted $1,500 in the near future were full of hype, hot air, and not very much sound reasoning. Those who predict the demise of AAPL are full of that same air, it's just coming out the other way.
AAPL is headed to $600 by the end of 2013, and at that level will be trading at a trailing P/E of 13.4 - still cheaper than its industry counterparts.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in AAPL over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.