Our Dynamic Duo: Apple And Facebook

Jan.14.14 | About: Apple Inc. (AAPL)

Apple (NASDAQ:AAPL) and Facebook (NASDAQ:FB) are well-followed for sure, but we think we have an interesting take on both. First, let's tackle some recent news on the "dynamic duo," and then let's cover the major bullet points to our respective investment theses on both.

Recent Catalysts

Official news of an Apple-China Mobile (NYSE:CHL) iPhone deal have sent shares of Apple soaring. We had highlighted initial reports of the announcement December 5, and we fully expect the new business to be a strong fundamental catalyst for the iPhone maker. China Mobile is the largest mobile operator in China by users, and even a low-single-digit conversion rate to the iPhone will move the deal at Best Ideas portfolio holding Apple. The iPhone 5s and iPhone 5c will be available in China Mobile and Apple stores across mainland China beginning January 17, 2014.

We think consensus estimates for Apple's earnings through the middle part of this decade are too low (on the basis of this transaction), and the company's committed entrance into China bolsters the sustainability of the firm's long-term earnings stream, offering support for our estimate of its cash-flow based intrinsic value. Though pricing information will be provided at a later date and competition from Google's (NASDAQ:GOOG) Android phones in China will be fierce, we fully expect the needle-moving agreement to benefit the bottom line over the long haul (particularly as Chinese consumers gain discretionary wealth).

Facebook (FB) is also being favored by investors. The social networking giant made headlines recently that it will add video advertisements to its suite. We think the move will be a huge earnings driver, given the size of the TV advertising market, and while there may be some user backlash, the breadth of the firm's reach will make it a very compelling proposition to advertisers (despite the steep pricing rates). We maintain our view that shares of Facebook are poised to rocket higher in the coming months, and we hold a call option on the company to capture our expectations of upside.

Facebook Investment Highlights

• Facebook earns a ValueCreation™ rating of EXCELLENT, the highest possible mark on our scale. The firm has been generating economic value for the past few years, a track record we view very positively. Return on invested capital (excluding goodwill) has averaged 24.8% during the past three years.

• Facebook's mission is to make the world more open and connected. People use Facebook to stay connected with friends and family, to discover what's going on in the world, and to share and express what matters to them.

• As global data coverage improves, the number of mobile monthly active users will continue to grow. Facebook looks well-positioned to seize upon this trend, and Facebook's younger demographics are increasingly accessing its platform from mobile devices. For younger demographics, advertisers might have to go to Facebook to find their desired target market.

• The range of potential outcomes with respect to Facebook's valuation are astounding. Though its business model doesn't have many comparable stories, we do recall a time when AOL was also the Internet. With such low barriers to entry, the landscape could be completely different in five years, posing both risks and opportunities.

• We think the likelihood of a single-stock bubble in Facebook is equal to or perhaps even greater than that of InfoSpace during the dot-com era. In the latter, InfoSpace was expected to become a monopoly in emerging wireless technologies, bringing the Internet to everyone's cell phone (making it the first trillion-dollar company). If the talk of Facebook possibly becoming the new Internet starts to expand across social media, the trajectory of InfoSpace's price increase may look minor to what Facebook could experience.

Apple Investment Highlights

• Apple earns a ValueCreation™ rating of EXCELLENT, the highest possible mark on our scale. The firm has been generating economic value for shareholders for the past few years, a track record we view very positively. Return on invested capital (excluding goodwill) has averaged 304.6% during the past three years.

• Apple's traditional computers continue to gain market share, particularly in the US, and particularly with younger consumers. The company's execution remains top notch, and it should continue to take market share in that segment.

• Apple has an excellent combination of strong free cash flow generation and low financial leverage. We expect the firm's free cash flow margin to average about 23.3% in coming years, and the firm had no debt as of last quarter.

• Apple continues to impress. The firm's rollout of the new iPhone 5 (and future iterations) should propel the firm's fundamentals ever higher. Though we're not expecting another blockbuster hit in our valuation model, we wouldn't be surprised if Apple delivers another one from its pipeline.

• Apple's cash hoard is more than some of the market capitalizations of the largest companies in the S&P 500. The company retains tremendous flexibility in this regard, and we continue to expect dividend increases.

• We like the company's track record of innovation and its extremely healthy balance sheet that will pave the way for significant dividend growth and opportunistic share buyback opportunities. We continue to believe Apple's shares are worth north of $600, with upside to over $750 on the basis of the high end of our fair value range.

Valuentum's Take

The Best Ideas portfolio continues to be well-positioned to capitalize on broader market trends (and individual valuation mispricings), and the Valuentum Buying Index, our stock-selection methodology, continues to help maximize returns. Though we have had nearly a full position in Apple in the portfolio of the Best Ideas Newsletter for some time, the Valuentum Buying Index offered conviction to add to the position at $442 per share in July 2013 and open up a full new position in the Dividend Growth Newsletter. We continue to believe Apple's shares are worth north of $600 (see here), with upside to over $750 on the basis of the high end of our fair value range. See our 16-page report here (pdf).

We estimate Facebook's intrinsic value to be roughly $80 (see here), and the shares have rocketed higher towards that level in recent months. The company continues to roll out endeavors that represent new revenue streams, and thus far, it has been able to recover from its very rough start as a public company. Though the call option on Facebook's shares (the position in the Best Ideas portfolio) may expire worthless, we're expecting further upside in shares and are levered to that expectation. We don't expect to make a change to our actively-managed portfolios at this time, but we like the fundamental performance of both entities.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within 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. AAPL, FB, and GOOG are included in the Best Ideas Newsletter.