Is Apple Stuck in a Trading Range?

Background:

I’m an Apple fan. I own multiple Apple products, and am a regular visitor to the Mac store. I’ve thought of owning Apple stock (AAPL), but have not done so because everyone I know is so admittedly smitten by them. When a company is that well known and loved, a lot of its growth is already baked in.

Back in 2005, I considered buying Apple stock when it was around $80. Times changed, things happened. I remember there was this investigation against Apple by the European Union. Then we had the legendary iPhone release and the stock shot up to $200. After a spectacular double top, it traded a few weeks back at or around the $80 mark I had considered back in 2005. A nice cyclical gut wrenching round trip, in spite of everything that’s happened in between.

(Before everyone gets really excited, I know Apple is up 50% in this rally. But up 50% in a 30% up market for a high beta stock like Apple (Beta is 1.5) is par course for the stock).

Issue #1: Overoptimistic and Overenthusiastic Fan and Investor Base

Now consider this well-researched but overoptimistic recent article:

Back in 1982, you could have purchased 100 shares of this company’s stock for $160. Those same 100 shares would be worth roughly $92,000 dollars at today’s split-adjusted share prices.

That’s a 57,400% return, something most people won’t ever see in a lifetime of investing.

Fortunately for us, this company’s prospects are only looking brighter. In fact, it has plenty of space to grow and do it all over again. And it won’t matter whether you’ve been there from the beginning or jumping into the bandwagon today - the ride looks to be profitable nonetheless.

Issue #2: Fundamentals

• That really sounds like a siren call to own Apple and ride the road to riches! Problem with this argument is SIZE. Apple is already a $100 billion dollar company. A growth of 57400 % would imply a market valuation of $57 trillion, or 4 times the current US GDP. That’s also close to the total world GDP! Trust me, it AIN’T gonna happen in your lifetime. Even arguing for a TEN bagger from here sounds like a stretch.
• Here’s my problem with a large cap high PE company: The growth assumptions imply that its market cap would be x% of the US GDP. Wal-Mart (WMT) was a high growth high PE flyer in the late 80s/early 90s.. Someone in the early 90s did an analysis that if the growth assumptions of Wal-Mart were true, its market cap would be 10%+ US GDP in another 10 years. It pretty much went sideways for the next few years. Apple will also go through this growth stock to value stock transition sometime in the near future. Note that this valuation argument is also true for most of the current tech horsemen, like Google (GOOG) and Amazon (AMZN). Earlier growth stocks like Microsoft (MSFT) have already made that transition, but only after years and years of sideways movement.
• The other thing is that Apple does not have a dividend. You might say that it’s reinvesting all that cash flow into high growth areas, but the growing cash balance earning rock bottom interest rate is inconsistent with that statement. We’re headed to a low growth world where investors will increasingly demand yield, and non dividend companies with optimistic growth assumptions will suffer.

Issue #3: Risks

• The risk is that a lot of Apple’s sales are in the developed world (US, Europe). In a world where consumers in emerging markets are expected to make up for any slack, I count that as a risky attribute of Apple. (For instance, the iPhone is a big flop in India.)
• In the PC area, the current slowdown should accelerate the trend of budget conscious buyers gravitating towards cheaper products (check out the new Microsoft ad).
• Further, the handset market is ultra-competitive with low barriers to entry. Even a revolutionary product gives you maybe a year’s headstart before the competition hits back with competitive but lower priced products. The handset market looks ripe for a shakeout in the next few years. Sooner rather than later, your margins are going to contract. Just ask Motorola (MOT) about their Razr experience.

Hmm.. let's see what else we have. Handset revenues recognized over multiple quarters? It’s already been priced in. High cash reserves? That’s never been a reason to buy a company.

When the iPhone was released, everyone was talking about how Apple was getting a slice of the carrier revenues. With the release of the 3G version, the story changed to how carrier subsidies would drive handset volumes. Never mind that no one’s talking of iPod growth anymore. Never mind that most Mac sales are in the slow-growth developed world, where consumer demand has taken a hit.

My point is that I’ve seen the story change repeatedly to justify Apple’s growth prospects. A lot of the good stuff is baked in.

Issue #4: Technicals:

Firstly, you cannot possibly ignore the massive double top. (And in case you think I'm imagining this, Louise Yamada seems to concur.)

More importantly, Apple was the darling of the previous bull market. New bull markets always bring with them new leadership. Leaders of the previous bull sit the next one out. Chances are, Apple may not go to the stratosphere as the article claims, but might be stuck in a trading range. The fundamentals based argument made above would also support this conclusion.

Fan boy articles arguing for Apple market cap to reach 4 times US GDP should give risk-averse investors cause for concern. Apple is and will continue to be a great company. Much of that is priced into the stock.

Full Disclosure: No positions

Comments

[Steeevo:]

So - you're telling us that you failed to make money from AAPL when they were low. Does that show that you're smart enough to say if they are worth buying right now?

I'm not saying you're entirely wrong - but you're certainly not right - and haven't really shown why someone should accept your reasoning.

From all that I have seen, Apple is not shooting to the stratosphere and in recent times has been tied pretty closely to the overall market. I expect that they will keep this pattern until the next product releases.
You assume some things have been priced in - particularly iPhone revenues. I think you're wrong on that - and I'm looking forward to the proof of that.
I'm glad you talked about market-cap articles by Apple fan-boys. They're usually pretty silly and not worth reading. Market-cap isn't what is important for the company - sales, profit and the future is more important than that. It would be nice if some people realized that and ignored the rest of the noise.

In the earnings report tomorrow - pay attention to the revenue that comes from overseas. I think your assumptions will prove wrong here too.
Of course - many people don't quite understand Apple - including some supposedly astute analysts

Apr 21 06:35 AM

[Timeline St...:]

I agree with Steeevo. You must hate making money.

You are so fixated on a 10-bagger that you miss a 1.5-bagger that did so in 1 month, and rather predictably.

Your positions should have read: "Full Disclosure: Dithering"

Apr 21 07:24 AM

[Roger Knights:]

"Even a revolutionary product gives you maybe a year’s headstart before the competition hits back with competitive but lower priced products. The handset market looks ripe for a shakeout in the next few years. Sooner rather than later, your margins are going to contract. Just ask Motorola (MOT) about their Razr experience."

The headstart is longer if the company's edge comes from an operating system. That takes many years to match. Furthermore, Apple is extending its software lead with its recent 3.0 update, and will extend its hardware lead in June with its new iTablet (or whatever they call it). The iPhone's cost of $200 isn't a significant barrier, and a $100 phone wouldn't offer much competition, since most of the cost is in the data plan.

I doubt that the deferred revenues of the iPhone are already priced in, since Apple's deferred revenues were the factor that beat analysts' estimates last quarter. They hadn't factored them in, and they strike me as slow learners.

Apr 21 08:06 AM

[Mac'em X:]

"Fan boy articles arguing for Apple market cap to reach 4 times US GDP should give risk-averse investors cause for concern."

Problem is: The article you quote DOESN'T argue that. It points to a past period of massive returns and argues for some future growth, but makes no claim that the SAME growth will come again.

Further, that article pegs the past growth at 5,460%; why are you quoting it as 57,400%? (Perhaps the author used the figure you quote, then later corrected it; is that the case?)

Other than the above, your article provides food for thought (though it'd be interesting to hear whether you think the Mac's "still plenty of room to grow its market share" factor isn't important). But as a humble suggestion, avoiding juvenile terms like "fan boy articles", and learning how to use "it's", will make future posts look more professional.

Apr 21 09:33 AM

[brewer:]

Rather myopic. You missed before, but now you are so convinced you're right that you resort to name calling, etc... You are so careful to assert what a great fan you are of the company. Sure you are. To me, that sounds like cover for another agenda.

What if Apple takes a huge chunk of Microsoft's market? It's already starting. Of course I am talking about the PC market, the mobile internet and music device markets (and online music, video, applications, etc... are already taken).

Also, the huge straw man about how Apple can't possibly become bigger than world GDP. Good one! But I suppose that is supposed to convince us it won't make money, or that the stock won't double (again) as it has many times over?

Apr 21 10:00 AM

[tivoboy:]

Honestly, I cannot understand why one would use the argument that an HISTORICAL return of 57,400% is cause for concern for future growth - not that there ISN'T concern, just that the historical growth of a company isn't the best predictor. Will there be growth, certainly, but it of course won't be at these levels.

Let's think about, umm, AT&T. It probably went public 100 years ago with a market cap of 10million, today with a market cap of 150 BILLION, what does that growth % look like? I'm certainly not going to use that % as an indicator of future growth from here.

Apr 21 12:47 PM

[reagan:]

This guy just doesn't get Apple. Future growth is already baked in?
You REALLY don't understand Apple!

Apr 21 01:49 PM

[Stephen Ros...:]

Your argument that AAPL is too big to grow its market cap is way too late. When AAPL was trading at $182, the company was too large to justify the growth that their PE implied. The bear market took care of that. In October 2008, when the stock price dropped, I went positive on AAPL. The company is still quite a ways from those lofty market caps and still is undervalued. Per my article: seekingalpha.com/artic...
" Think about it this way: When AAPL was trading at $182 it had a $156 billion dollar market cap but was slated to earn $5.22 for 2008. At that market cap, AAPL was the eight largest company in the world. Only Exon, EON, China Mobile, GE, Walmart, MSFT, and PG had market caps over $200 billion at the time.

In order to vault to a $200 billion dollar market cap, AAPL needed to demonstrate either big profits or growth in earnings. The $5.22 just didn't do it. By the law of mass, companies that become larger grow more slowly; hence, small companies can have startling growth while large firms begin to slow theirs. "

Unfortunately, it appeared to me that AAPL had a heavy load to lift if it was to increase its share price to a level of a $200 billion dollar company, $240 a share. At the time, it seemed AAPL had no where to go but down.

The bar just got lowered substantially. AAPL is now a $99 billion market cap company, no longer a member of that tiny club of behemoths. It's a stock that has room to run. "

Apr 21 04:46 PM

[Sajal:]

@Stephen, I agree with you. This argument would have been even more persuasive at 200. But between 60 and 200 is where I see Apple for the next few years, or stuck in a range. You could have made the same argument for Microsoft anytime since 1998 and still been correct.

Look at Microsoft. The stock is where it was in 1998 (buy and hold). Net income in the meantime has gone up 400%, from 4.5 Billion to 18 billion. Apple could also quadruple it's net income without the stock going anywhere over the next few YEARS. That's the kind of growth to value stock transition I'm talking of.

I looked at www.indexarb.com/index.... Out of the 20 largest S&P 500 companies, the only ones not paying a dividend are Google and Apple. There’s a good reason for this.

@Mac'em X. Thanks for your valuable feedback. Yes, I think that number was changed. But still, 5.4 trillion is HUGE. I guess as far what is priced in or not is a matter of opinion!

Apr 21 05:20 PM

[aapladay:]

If growth continues, even at a tepid pace, then deferred earnings and revenue will soon combine to produce $10 a share in earnings. Cash may be over $40 billion in about a year. $200 a share may soon be a safe base for the stock. I think this could happen in a little over a year. Earnings tomorrow will give me a clue if I am on the right track. Keep on eye on non GAAP earnings and the amount of deferred earnings in GAAP earnings.
I know, I didn't dig out any real numbers for this, so feel free to do so and provide a more accurate depiction.

Apr 22 02:35 AM

[Techtrader10:]

Good analysis Sajal. Well thought out and well presented. I agree its time to find the next rising star...

Apr 22 09:33 AM

[Zoltan L. K...:]

In fact AAPL just broke out of a trading range.

Apr 22 02:02 PM