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Thesis

Ever since Apple (AAPL) took the tech world by storm, expectations for the company have soared ever higher to new levels. But at some point, investors have to realize that no business model yields a 20% year-over-year gain in earnings every quarter. Apple might not be the exponentially growing company it once was, but it still is an elite company with plenty of room to grow along with solid fundamentals and an attractive valuation.

The Apple Of Yesterday Versus The Apple Of Today

Depicted below is a chart of the year-over-year quarterly revenue growth for Apple. As you can see, growth has decelerated in recent years. The iPad Mini and the iPhone 5 managed to keep sales about flat in the most recent quarter, where they were at $35.3 billion. This is simply an astonishing amount of money to bring in over the course of three years. Although it might not be a 10% increase over the last quarter, it is still just a tremendous amount of money.

AAPL Revenue Quarterly YoY Growth Chart

AAPL Revenue Quarterly YoY Growth data by YCharts

Even more impressive was the revenue reported for the nine months ended June 29. This year, the company brought in $133.4 billion compared to last year's $120.5 billion, a 10.83% increase. Admittedly, though, net income decreased 11.9% as a result of shrinking margins. This margin problem, though, will be solved when new products are released in the future, which I will address in a moment.

As you can see, Apple is not recording explosive growth in revenues or earnings anymore, but the company is still producing impressive results. Revenues were likely flat in the last quarter because the iPhone 5 was relatively old news. New product releases will drive future growth. But for now, we must accept that regularly increasing sales by 20% or more cannot be expected. If a company like Coca-Cola had sales remain about flat, there would not be a huge issue about it. I know this is a bit of an exaggerated comparison because of the different industries, but investors must understand that Apple is now an established company. Growth can still be expected, but we must also be ready for the slow quarters that come with age. Apple has saturated multiple areas of the tech market with their products, and market acceptance can't really get any higher. When the iPhone first came out in 2007, Apple has something to prove. And when the company was able to prove that they changed the game in the cell phone market, exponential growth was rewarded as a result of customers across the world hearing about and wanting the iPhone.

But those days are over. Apple is an established company that has brought themselves to prominence as a corporation. From this point on, investors can look for earnings growth to come from new product developments as well as margin improvements. In September of last year, Apple hit $700. It is now trading at $473. This drop was a result of investors realizing that Apple is no longer the growth machine it once was. But what they (and thus the market) didn't realize is that this doesn't mean Apple is a dying company. It is just a different type of company. A few years back, Apple had to prove that its products were worthy of filling up stores across the world and earning greater market acceptance and penetration. Now, the company must continue to provide products that are worthy of this prominence. With the iPad Mini and the iPhone 5, they have done that. In the coming years, we can expect that they will continue to do so.

Products Will Act As Catalysts

There are a number of rumored products Apple has that are highly anticipated for release. A few of them are the iPhone 5C, the iPhone 5S, a TV, and the iWatch. The new iPhones are the closest to release, as there are numerous reports that they will be announced on September 10. Both phones will play a key role in bringing in more sales. The 5C is expected to be a low cost iPhone that will lack some features in order to avoid product cannibalization, which appears to be a bit of a problem for Apple. But in reality, I would say that the cannibalization is not as much of a problem as some people might think. Even if people elect to buy older iPhones for lower prices, these are still high margin products. Back to the 5C, though. This phone can be expected to contribute significantly to revenues and earnings. As consumer spending is limited among the lower to middle class during times of struggle, this cheaper phone should play a key role in filling the gap that lacks an affordable smartphone on the market. Nowadays, it seems like almost everyone has a smartphone. It's almost like you're at a disadvantage if you don't. But now, even lower income families can afford to purchase a smartphone, thanks to the 5C. Earnings will really move higher if Apple can price the 5C effectively enough to avoid cannibalization while also implementing a decent margin. The announcement of these products will hopefully drive the stock price up a bit if Apple does a good job with their presentation and public communication, which they always have.

The 5S will also bring in decent amounts of revenue. As iPhone users get ready for an upgrade, it is likely they will stick with Apple for a number of reasons. One of the reasons is that the iPhone is simply one of the highest quality smartphones out there. It should be no mystery as to why it brings in millions of dollars each year. Second, customers can count on Apple to always be improving their products. With new releases of their iOS software (notably iOS 7) being anticipated, it is unlikely that many customers will want to ditch before the improvements. And third is a strength that has gone relatively unappreciated. The benefits of iMessage have been highly underrated. Believe it or not, iMessage brings customer loyalty to a whole new level. In today's world, there is no doubt that people want things, and they want those things now. Instant gratification is what it's all about. And iMessage serves this need. When all of your friends have iMessage and you're stuck with normal old text messaging, you're not going to be too happy. Even if other companies develop a similar service, it's not like someone will be able to rally the troops and switch millions of people over to a new smartphone. High quality features like iOS 7 and iMessage help Apple retain a high market share in the smartphone market. And as a result, when people are ready to go for an upgrade, it is likely that they will buy the iPhone 5S.

Products such as the iWatch and the Apple TV are anticipated as well, but these are longer term catalysts. We won't see much of an affect from them until next year, but it is still always good to have the public waiting on the announcement and release of new products.

The Main Risk And The Margin Of Safety

Apple's major risk is undoubtedly its competition. Some of this competition is from the smartphone market. According to a recent report by comScore, Apple still leads this market with a share of 39.9%. The runner up, Samsung, is gaining share but is still only at 23.7%. With the customer loyalty and other topics I previously addressed, we can expect this market to hold a similar landscape into the near future. Apple also competes fiercely with Google (GOOG) to become the greatest tech giant. Both of these companies have their hands in a little bit of everything. Let's compare the two:

 AppleGoogle
Revenue$169.40 billion$55.80 billion
Net Income$37.75 billion$10.94 billion
Gross Margin38%57%
Operating Margin29%24%
Cash And Investments$146.62 billion$48.09 billion

As you can see, both companies have very impressive statistics. Apple, though, is still larger and has a better operating margin. Also, Apple blows Google away in terms of cash and investments. As time goes on, this will always be one of Apple's strengths. With such great cash reserves and investments, they will be in great financial shape for many years to come. Soon, though, Apple should begin to make a more effective use of the pile of cash. Some acquisitions or expansions couldn't hurt. With Apple's debt to equity of .13 and Google's .10, both companies seem to have low amounts of risk and can afford trying out a few acquisitions. We will just have to wait and see if Apple takes advantage of this opportunity.

Also, Apple has a significant margin of safety worked into it, especially when you consider all the hype that has surrounded it for the past few years. Apple is trading at 11.85 times earnings while Google is trading at 25.57 times earnings. Apple's price/sales of 2.51 is impressive compared to Google's 5.29. Apple also has the more attractive price/book of 3.44 compared to Google's 3.74.

On top of all this, in the midst of writing this article, I heard the news of Carl Icahn announcing his "large position" in Apple. Also, he requested that Apple take their share buyback program a bit further. Essentially, the purpose of a buyback is to find an effective use of cash, one of the issues I addressed earlier. And when executed correctly, buybacks occur because the company feels that the shares are significantly undervalued. For example, a company wouldn't buy back their shares at a price of $2 if they felt each one was only worth $1. But if they believed the value was $3, it would be a different story. With such an experienced and well known investor as Icahn believing that shares are undervalued, it really improves the overall idea of an investment in Apple.

With such strong fundamentals and chances for growth, the fall from $700 to $400 was way overdone. It might not be a bad idea to buy a few shares of Apple as it climbs its way back up.

Source: Why The Bears Are Wrong About Apple