Apple: Is It Really Too Cheap To Ignore?

| About: Apple Inc. (AAPL)

Apple (NASDAQ:AAPL) has indeed never been cheaper than now, at least not in the last 15 years. But does it really mean that the stock is too irresistible to pass?

Valuation inconsistencies

If we needed more proof that Google (NASDAQ:GOOG) has stolen Apple's mojo, according to a report by Citigroup, the Mountain View search giant has recently surpassed Apple to become the most-owned stock by the 50 biggest actively managed U.S. mutual funds. This is yet another sign of how Apple has turned from the darling of Wall Street to one of the most hated stocks in a matter of a few months, if not weeks, making the stock fall like a rock. Specifically, shares haven't been so low since January 24, 2012, the day before those hard-to-forget Q1 2012 results came out. Apparently, though, the market has totally forgotten them: since then, revenues have grown 45%, EPS has grown 65%, and cash (plus its equivalents) has grown to the modest amount of $137b.

This has lead to Apple being the second most profitable company in the world and the most flush of all, but, at the same time, also one of the cheapest stocks in the whole S&P 500. If we compare it to Microsoft (NASDAQ:MSFT), Google and Exxon (NYSE:XOM), the results are staggering (see chart for reference):

  • 30% cheaper than Microsoft
  • 30% cheaper than Exxon ex-cash
  • 3.5x cheaper than Google

Actually, ex-cash, Apple's market cap is now terribly near to that of Google, even though it makes 4x more money. To justify this situation, I don't see other possible explanations apart from:

a) almost every company in the S&P 500 is overvalued, especially Google

b) Apple, with this level of income, is clearly undervalued

While there are many people reckoning that the markets have now become overvalued, option a) just doesn't seem possible. This leaves us with b). Pay attention to the words I used, though: Apple is clearly undervalued with this level of income: as much as it may seem trite, in fact, if Apple's income was to contract, this valuation might not seem so cheap at all. And this is clearly what the market is currently pricing Apple for: an imminent decline in earnings. But with Apple, forward P/E (which, by the way, is a metric that I find deceptive and unreliable to say the least, since it is based merely on analysts' predictions) or other metrics, are currently useless, because the company is in a never-seen-before situation.

Think, again, about Exxon for example: in a mere matter of valuation you'd look at the oil giant, see that it makes more money than Apple, that it is worth less money than Apple, that it sports a dividend yield (slightly) higher than Apple and, at first sight, it would then appear cheaper. But if you also looked at their respective bank accounts, you'd see that while Apple has almost $140 billion in cash, Exxon has debts for $34 billion. Now the former doesn't look more expensive. In fact, Apple currently produces so much cash that if it was to grow 0% for the next two years, by mid-2015 its bank account would be worth more than the whole of Microsoft (see chart for reference).

(Click to enlarge)

It is also true, though, that Apple has been so stubbornly attached to this money, frighteningly reminiscent of Scrooge McDuck [the Disney (NYSE:DIS) character who makes money just for the sake of making it] that Mr. Market has probably lost hope to see it employed in something accretive, so it may have just forgotten about it.

New categories of products no more

For pricing the stock at such a low valuation, Mr. Market is clearly thinking that Apple is not going to shake the world again with yet another category of products, as it is speculated to be ready to. Or, that it is going to do it while considerably lowering its margins (for example with a cheaper iPhone). I really doubt that a cheaper iPhone will ever see the light, though, because in the words of Tim Cook:

"[Apple] wouldn't do anything [it doesn't] consider to be a great product. That's just not who we are"

A cheaper iPhone would mean compromising on materials, compromising on components, maybe even compromising on the OS. That's not what Apple is at all, and that's why the only "cheap" iPhones Apple is going to sell are the ones that are already there, like the iPhone 4 (which starts at $0 with a 2-year contract in the U.S., and sells around the world at 35%-40% discount to the iPhone 5). For this reason, I think that margin contraction worries are overblown.

On the other side, the two new categories of products that are highly speculated to be in the pipeline are the iTV and iWatch (even a larger iPhone starts to make a lot of sense). To be fair, iTV rumors have diminished, since such an object has been promised by analysts for years now, with no real clue it really exists. iWatch, on the other hand, seems pretty real, and it's expected to be incredibly profitable. Corroborating this rumor, Jason Schwarz has a nice article here on SA depicting how Disney (the CEO of which sits on Apple's board) is paving the way for an iWatch - and showing the incredible potentialities it'd have.

You may also remember that iTunes head Eddy Cue recently gained a seat on Ferrari's board. Well, from Geneva we're even learning of an upcoming partnership between Apple and Ferrari, which could be extremely accretive for both companies (in fact, Ferrari is the most powerful brand in the world).

All signs point to pretty impressive things in Tim Cook's pipeline, which now more than ever are essential not only for revenues and profits to rise, but for them not to decrease. Because, without a new product, it is becoming apparent that Apple is going to contract. Many have even speculated that the CFO guided for the first contraction in a decade during the last conference call. The Samsung (OTC:SSNLF) threat is proving real, and Apple needs to act.

Final thoughts

The problem is that Apple is acting slowly: the management seems to be doing its best to let the negativity around the company, and the stock, spread in the media and in the market undisturbed -- in the face of a plummeting stock, and the savings of thousands of retail investors dreadfully shrinking, Tim Cook has done nothing to push the stock up again apart from saying "focus on the long term." No new product announcement, no new buyback program, no big acquisitions, no nothing. Steve Jobs used to do the same, that's for sure, but these days are different than a few years ago. First of all, Steve Jobs was, well, Steve Jobs, the guy who founded Apple and reshaped the technology world countless times, not his successor who has still to prove himself. Second of all, at no other time in Apple's history has the stock lost almost $300 billion in market cap, leading small fortunes to annihilate themselves and pension savings to dreadfully shrink (there are stocks that fall every day, and everyday there are people who lose money, but when it's the most valuable company in the world that falls, many more people lose money). And finally, at no other time has the pressure on the company to use that cash been more strong, mainly because there was less cash, a lot less cash, and the stock wasn't worth so much.

Despite all this, Tim Cook has (yet) done nothing.

So yes, the stock is terribly cheap, yes an enormous amount of cash is there, but when buying the stock you have to be aware that you're putting your savings in the hands of this guy, who may very well have a heck of an ace in the hole yet to be shown (without which, remember, the stock might not be so cheap at all) but has until now ridden the stock from $700 right down to $420 impassively. Neither is to say that the chart still looks awful (that is, in the same conditions that I analyzed here a few weeks ago).

Until there is a neat sign that Apple can turn its fortunes (and those of its shareholders) around, as much as the stock may appear irresistibly cheap, I wouldn't touch it.

Disclosure: I am long AAPL, DIS. 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.