Apple (AAPL) has always had a following, but its popularity soared phenomenally in the last four years. The bull run that the stock went through from early 2009 to September 2012 created a bit of a craze among market participants after the $700 level the stock once touched in late 2012. Once Apple fell from those giddy levels, then -- like many once-popular Hollywood and sports stars who shall remain unnamed -- the market perception and reaction seemed disproportionate to Apple's real value.
In this article, I am going to tell you that even if Apple never reaches those levels again, it is still an invaluable stock that you want to definitely invest in. I am going to propose five reasons for that. Frankly, and with all deference to bulls and bears, it is time we discovered another animal in the market -- the slow but sure turtle. Let's say I am "turtle-ish" on Apple. While the bull is an optimist and the bear pessimist, the turtle, in my opinion, is a pragmatist.
It's time we take a pragmatic look at Apple, treat it just like any other large-cap company, and get out of the bigger-than-life image the "brand" Apple has become. Fundamental analysis and future growth prospects should now be the only factors to consider, rather than the past success of the stock or whether the iPhone is marginally sleeker than the competition.
Before proceeding, let me compare the performance of Apple to the Nasdaq Composite Index and Nasdaq Technology Index over the last six years, three years, and one year, respectively, below.
Click to enlarge images.
The above graphs clearly show that Apple has always been an outperformer, both in comparison to the technology index (NDXT) and composite index (Nasdaq). It has always given tremendous returns to its shareholders. It's just in the last six months that the stock has not really fared well. The reason, I propose, is a correction in the overvalued stock. Right now is the time to figure out where the stock might go from here, rather than continue analyzing the previous fall in its price. The discussion below focuses on the factors that reflect there is upside potential in the stock and investors should take a long-term position:
- Strong fundamentals
- Increased R&D investments
- Increasing focus on non-hardware business
- Growing smartphone market opportunities
- Emerging market focus
1. Strong Fundamentals
Apple sold over 50 million iPhones and 23 million iPads in the last quarter. Return on assets over the past 12 months is 20.6%. Apple has a huge cash pile of $137 billion. Since the assets in the return on assets calculation include cash and marketable securities, this in itself is an exceptional performance and an indication of the huge profit margin (58%) of the company. This profit margin is the highest for any other player in the same industry, as Apple enjoys a premium brand image. Most people will buy Apple's products not merely because the products are so good, but because they want to own Apple. This has been the most prominent factor behind the huge anticipation for any new Apple product launch.
The return on equity has been 38.4% over the same period. Return on equity affects the long-term growth of the company in a big way as the long-term growth of the company is equal to the earnings retention ratio times return on equity. The dividend payout ratio of the company is 12%, which makes the retention ratio 88%. The long-term growth of the company is therefore around 33%, which is nothing short of phenomenal. This will drive the long-term appreciation in the stock price of the company for sure. The return on invested capital (ROIC) for the company is also a strong 37%.
Over the last three years the average EPS annual growth rate was 72%. Though the growth rate has slowed down in the last three quarters, the expectation for the EPS growth rate for the next five years is also close to 72%. Other positive factors that must be considered includes zero financial leverage. A company with no long-term debt has no interest cost, has complete freedom with no debt covenants, higher credit ratings and access to cheap debt when required sometime in future. The trailing P/E ratio (9.9) of the company is lower than the industry average (12.2) and sector average (21.3). The company is trading at more than 50% discount to S&P 500 on the basis of P/E. This signals some undervaluation in the value of the share price.
With these fundamentals, any other stock would have gotten a "strong buy" rating by every analyst, but with Apple, everyone expects a little more. That is not pragmatic.
2. Increased R&D Investments
One thing that investors should keep an eye on is the new product launch of the company. This is because for Apple, the event of a product launch is what decides the stock's fate until the next launch. A snapshot of the first quarterly earnings is given below. It can be found that the R&D expenditure increased from $758 million in the quarter ending Dec. 31, 2011, to $1010 million in the quarter ending Dec. 29, 2012. This can be viewed as a sign of things to come. One more path-breaking product launch can give the stock a real push.
3. Increasing Focus on Non-Hardware Business
It is rumored that Apple is developing a range of innovative online services, including true virtual wallet mobile payment system. News of the launch of music streaming services has already been floating in the market. Apple will get the first mover advantage if the mobile payment system is launched as it already holds millions of credit card and debit card numbers. So the users will not have to go through any more registration process specially for using the application. Apple is also planning to launch its own internet radio services.
All these new initiatives signal that Apple has been trying to diversify and reduce its dependence on just the hardware business of iPhone and iPads. This was suggested by Morgan Stanley's analyst Huberty after his meeting with the Apple management. These initiatives will lead to a better revenue stream and monetization of its large user base.
4. Untapped Non-Smartphone Market Opportunities
comScore recently published a report in which it was mentioned that Apple's market share in the smartphone segment has increased to 38.9%, which is a 3.9% increase from the previous report. This also means that Apple has been able to capture more of the smartphone platform segment with 38.9% share, an increase of 3.9%, though Google (GOOG) is still the clear market leader.
Market penetration for smartphones so far has been just 57%, which, although an 8% increase from previous report, neglects the fact that a whopping 43% mobile phone users still do not own smartphones. The graphics below shows that the smartphone penetration in U.S. is expected to reach 80% by August 2014, which is a huge 26% increase in the next 16 months. This is a huge opportunity, and the company capturing this market will emerge as a market leader in the next few years.
There are many applications which people prefer to use only on tablets and not smartphones. This is because the larger screen size makes the application more useful and convenient to use. The revenues generated from the applications used for tablets are expected to surpass those that are used on smartphones in the next few years. It has already reached $8.8 billion, which is one-third of the total revenues ($25 billion) generated from applications used on all hardware combined. Apple enjoys more than 65% of the market share in this segment. With such a rapid expected growth in the segment, Apple will capture even more market share because of its dominance in the tablet market.
5. Emerging Market Focus
Apple is now focusing more on emerging markets like India and China. The growth in the sale of smartphones in the later part of 2012 has been a whopping 75%. Apple was the second largest player in the fourth quarter with 15.6% market share, only behind Samsung which is still the market leader with 38.8% share. The success in India can be attributed to the company's ability to adapt to the Indian smartphone distribution market. India is expected to become the third largest smartphone market by 2017. The graphics below shows the top six smartphone markets in the world, based on their share of global smartphone shipments.
With its recent "cashback" offer, the company is ready to capture the huge market that is still largely unpenetrated. If Apple is able to get this right, it will not only help in the company's growth, but also lead to a market share loss for its competitors like Samsung, Nokia and HTC.
Not just India, Apple is also the second largest player in urban China after Google's Android.
Because of Google's issues with the Chinese government, a majority of the Android devices in China comes without Google services. This leads to Apple capturing some of the market share from Google's Android. Apple, though yet unable to capture the Chinese market from a number of Chinese players, has recently been doing better. It has sold 2 million iPhone 5s in the first weekend of sales in China. Its quarter-to-quarter shipment to the country was up by 30%.
It is a widely accepted opinion that Apple's stock has moved from being a growth stock to a value stock. Therefore returns like before are now not probable, unless Apple comes up with a path breaking product that changes the dynamics of the industry. If the market value of the stock is analyzed according to the fundamentals and future growth prospects, it would definitely seem undervalued. Strong financial performance, growing market share, increasing opportunities, diversification in terms of offerings and geographies will drive the growth for the company.
Investors would definitely want the huge cash pile to be used, either by paying them dividends, or by acquiring any high growth young company. The current dividend yield for Apple's stock is just 2.5%, which might not seem very attractive to some investors. The company has such a huge cash pile and an unparalleled ability to generate free cash flows, $0.28 for every dollar of sales.
Bloomberg analysts believe that the company will raise its dividend 56% to $4.14 a share per quarter. This is equivalent to a dividend yield of 3.7%, much higher than the current yield of 2.4%. It could also triple its buyback program to $30 billion over three years. Overall the company has announced it will return $45 billion to its shareholders over the next three years. At the current share prices, it doesn't look like a bad deal at all. With the company earning more than $2 billion with just its iTunes, the revenue model is very strong and a noticeable upward price movement within the next twelve months is expected. A price target in the range of $500 to $520 is very much possible in the next one year.
In sum, there's no reason to be bullish and no real cause to be bearish. Take a pragmatic look at this stock, see how strong the company is in its peer group, and also note that it has gone down as far as possible. It may dip some more, but then it can only rebound from here, considering all the aspects I just discussed.