Background: This article continues a string of cautious articles on Apple Inc. (NASDAQ:AAPL) which began on the Braeburn Forum in 2012 (in the form of posts from me as moderator) and then on Seeking Alpha beginning last year and continuing with a recent bearish article earlier this month (see below). When I switched from raging bull to bear in the summer and especially early fall of 2012, my opinion was strengthened a good deal when analysts began slashing earnings estimates. At that time, estimates for fiscal 2013 (ending Sept. 30 2013) were well over $50/share. We are now looking at consensus estimate for fiscal 2015 under $47/share, and earnings estimates have been trending down again recently.
Given a stock that continues to set lower reaction highs despite fervent fan support, this pattern should be interpreted cautiously. In a bull move, a stock moves up and generally earnings beat expectations. AAPL is now trending down, and earnings estimates are doing the same.
Investors looking for new money buys should, it is argued below, look for less picked-over names. However, most stocks rise over time when dividends are properly counted, and AAPL has already had a meaningful percentage move down from recent high, so my point is that other stocks look more attractive. As a long-only investor, my argument is not that AAPL is heading lower, merely that the weight of the evidence favors omitting it from purchase for new money, and considering selling it from a performance-oriented portfolio with a short-intermediate term bias. I am thus not in the short AAPL camp.
I believe that there are numerous discrete arguments against AAPL which taken in the aggregate pose problems for AAPL bulls. These anti-AAPL points include the following ten points. Please excuse me for starting a big egocentrically:
1. The overwhelmingly-hostile response to my last AAPL article was bearish from a contrarian perspective. That article, published by Seeking Alpha on Feb. 11 with the stock at $536, was titled Will Apple Emulate Gold's Plunge? It was criticized by numerous commenters, mostly on the grounds that Apple Inc. is very different from a lump of gold, the monetary metal. However, that's so obviously true it hardly needed to be said, but I said it anyway in the introduction to the article:
This article makes the case that even though AAPL and gold are very different assets, the psychology of becoming the world's favored, hottest investment may lead to similar price action ...
Very different assets, indeed. But, technical analysis is all about similar chart patterns for different assets.
The fact that AAPL bull after AAPL bull piled on my otherwise unremarkable article in large part making fun of me for confusing a metal with a consumer electronics company suggests to me that too many of them are a bit overwrought.
I continue to hold to my longstanding analogy that the overwrought finales to the precious metals boom into 2011, and the histrionic AAPL boom into 2012 and even 2013, each sucked in too many newbies who did not understand the assets and why they had been so attractive for so many consecutive years. That phenomenon, which also involved experienced hands stepping aside when the public was drawn in to create a spike top, has been seen many times. It does not matter if the asset is a tech company, a commodity, a currency, etc. The psychology is the same. Trend-followers come in after the media publicizes the massive move that has already occurred. At some point, these trend-followers become "dumb money" and get trapped; and the length and strength of the bull move also keep the true believers (aka smart money) wanting to stay in for the full move, the height of which cannot be known in advance.
For example, the NASDAQ peaked in March 2000, bottomed 2 1/2 years later, then had another bottom in 2003, basically creating a 3 year bear market. Then, except for the 2008-9 liquidation events post-Lehman's failure, it's been bull market action for tech-telecom ever since. Similarly, gold's wilder sibling silver, peaked with a massive spike toward $50/ounce at the end of April 2011, and may have completed a similar 2-3 year bear market. Gold's action has been less wild but not dissimilar. It may be that AAPL shares could be undergoing such a digestive process.
2. The charts are not dissimilar between some of these assets. Let us compare a gold chart, that of the well-known SPDR Gold Trust (NYSEARCA:GLD) with AAPL:
The charts from the spike tops for the next 2-3 years also look similar. A strong kickback rally that sucked in the bulls took gold from a peak of $1900 (or so) to $1800. AAPL, which moved much more than gold given its greater dynamism as an industrial company rather than simply an inert monetary metal, had a greater fall, but also had strong sucker rallies after its double peaks to $640-ish and $700+ in 2012. Since then, we continue to see what we saw in gold (and silver), which is lower highs on the enticing rallies.
So far I have not addressed whether I think that AAPL will have a meaningful fall from here. My answer is that since I'm not a short seller and do not think AAPL is a great short selling opportunity for those traders who engage in that pursuit, the answer is that I see the risk of a large drop-off from here as too high to make AAPL a safe entry for new money until more time elapses. The reason for my view is the identical reason many people have the opposing view, namely valuation.
3. The problem with AAPL's valuation: AAPL bulls typically point to a 12X P/E to say how cheap the stock is.
I would suggest that price to earnings ratios have misled more investors than any other valuation metric. This is probably truer now than in prior decades. After all, I began investing in 1979 as a 29 year old. Among the first investment books I read was Graham and Dodd's Security Analysis. As Wikipedia discusses, this 1934 work:
chided Wall Street for its myopic focus on a company's reported earnings per share, and were particularly harsh on the favored "earnings trends." They encouraged investors to take an entirely different approach by gauging the rough value of the operating business that lay behind the security...
To oversimplify, the wreckage found on Wall Street from 1932-4, when the book was being written, allowed numerous corporations' shares to be purchased for less than net working capital. As late as 1955 or beyond, Ben Graham decried the fact that only about 30 such examples could be found on the NYSE. Today there are probably none.
So, AAPL shares are not cheap simply because there is over $100/share in financial assets net of debt on the company's balance sheet. This point would be true if there were no contingent taxes should all foreign financial assets were repatriated, a necessity should taxes be paid out. AAPL shares are not cheap on the basis of earnings some quarters from now, because those earnings have not occurred yet. Furthermore, people may receive dividends or obtain capital gains in taxable form. Investing today often involves paying money that has had a haircut in the form of income and payroll taxes, then paying taxes on the income. Paying after-tax money to receive taxable income means that more money must be returned pre-tax than was invested simply to break even, inflation or competing tax-free interest rates notwithstanding.
AAPL shares are simply not cheap, at least not that can be proven in February 2014.
Actually, here is why the shares are expensive:
4. Apple's price:sales ratio is high for a consumer electronics stock. First, we must look at AAPL's market cap, #1 in the U.S., and note that the net cash and marketable securities on Apple's books represents almost the entirety of its retained earnings. Thus, AAPL's asset concentration in financial assets rather than brick and mortar that it owns itself is not an extraordinary situation. AAPL trades at a fairly normal price:book ratio for a high-quality stock, but in a stock market that trades roughly at one times sales, AAPL trades at about 2.5X sales per share, with slow sales growth assumed for the next year by analysts. This price:sales ratio is a danger point for the shares.
We know from the examples of Blackberry/Research in Motion (NASDAQ:BBRY), Dell, Hewlett-Packard (NYSE:HPQ) and several Japanese tech consumer electronics stocks that were high flyers decades ago that operating margins of dominant consumer electronics companies can take major sustained hits. This phenomenon tends to have outsized negative effect on price:sales ratios.
AAPL bulls often take its very high profit margins for granted. I do not.
Just this week it was reported that Microsoft (NASDAQ:MSFT) is slashing the price of its Windows 8.1 operating system from $50 to $15- and perhaps more, according to other mentions I came across on the Web.
One wonders what the implied price of Apple's iOS is for the iPhone and iPad. Certainly, it's a fine OS. But does Apple have a perpetual monopoly on small device operating systems that meet people's needs? Isn't the latest Android version pretty darn good? What about the future for Samsung's (OTC:SSNLF) tizen? How long can Apple avoid yet lower margins for the iOS line?
These sorts of margin cuts are deadly to profits, especially as Apple expands to less wealth parts of the world than the U.S and other "first world" countries. Apple is going to have to compete on price if it wants meaningful volume. There is no easy answer other than rapid and relentless innovation along with extreme costs reductions.
We have started to see this sort of problem, with earnings estimates tailing off again recently:
|EPS Trends||Current Qtr.|
|7 Days Ago||10.13||8.61||42.77||46.22|
|30 Days Ago||10.31||8.77||43.08||46.47|
|60 Days Ago||10.88||9.01||43.71||47.89|
|90 Days Ago||10.75||8.96||43.45||47.70|
Apple has another problem that few talk about:
5. Vaporware. Through proxies such as friendly analysts, Apple has produced a form of vaporware in a de facto manner without doing so in the overt way that embarrassed a number of other companies in the '90s. Nonetheless, when favored analysts in prior years assured us that a major Apple TV was coming soon, or when we were told that other major devices such as a blockbuster wrist device was coming soon, we were being sold vaporware. How much was Apple Inc. involved in those reports? I don't know, but we did not see Apple definitively refute those optimistic statements.
Worse, we know that Tim Cook, Apple's CEO, has for over a year been promising great new products coming.
Where are these products?
My thought is that with SJ fading before he passed away, there has been a creative vacuum. We know from "Inside Apple" by Adam Lashinsky and other sources that Apple has typically developed new products in a top-down manner. With SJ never coming back, why isn't it quite possible that Apple could have entered into the sort of funk that, for example, gripped Disney (NYSE:DIS) after Walt left the scene, only returning for good after Michael Eisner took the reins many years later?
The faithful who point to certain innovations that came from Apple in the post-SJ era 1.0 beginning in the late 1980s have to face the fact that when SJ returned in the '90s, the company was more or less bankrupt. But in weighting the uncertain future, we should include the possibility that Apple gets "RIMMed", or just as accurately, that it may go or at least threaten to get "Appled" (circa mid-1990s).
Just look at the strategic mess that Apple has made of the iPhone. The iPhone, and its iOS operating system, stood alone at least in people's perceptions as the only high quality choice for several years. Perhaps Apple could have done with smartphones what Microsoft did to it in desktop/laptop computer operating systems and what Google did in search/advertising. Yet it did its usual Apple thing and kept margins high, generated massive amounts of cash -- all great accomplishments -- but it left the door wide open for Android. What SJ and company accomplished with the iPhone beginning in 2007, including the hardware with the high quality glass touchscreen, was so important that it could and in my view should have led to Apple obtaining a legal monopoly in some aspect of smartphones, but here we are in 2014 and Apple has been marginalized in some important parts of the world in smartphones.
Apple has done better with tablets, but critically it has not deigned to compete in the substantial market for truly large smartphones (often called phablets). It is now not merely late. It is very late, so late that it is clear that both SJ and Tim Cook have made strategic decisions. The phablet, i.e. a large smartphone, serves as both a smart phone and tablet for many road warriors and general consumers in the U.S. In less rich regions, such as in many parts of Asia, finances are often tighter and the phablet is a necessity rather than a choice. Why was this high growth area largely ignored by Apple? Did it really think that making the iPhone a little taller, but retaining the famed one-hand grasp capability (fragmenting the iPhone's aspect ratios by doing so) was a meaningful response to the phablet challenge?
6. The vision thing: President Bush 41 made fun of the "vision thing" in politics. In Apple's field, the vision thing is everything. Think what Mark Zuckerberg et al have done with Facebook (NASDAQ:FB). FB's enterprise value is already about half of Apple's. This is incredible. Add in Twitter (NYSE:TWTR), LinkedIn (NYSE:LNKD), and a few others and you can see how much Apple has not accomplished. Why has Apple left so much on the table for others to scoop up? Why is Microsoft stock resurging? It's not enough to say that AAPL is up over the past few years. It after all has been living off SJ's accomplishments. The point is that the tech sector related to Apple's field has created vast new stock market value while AAPL has been struggling to maintain its own market value via conventional maneuvers such as share buybacks.
SJ had the vision for the 21st century Apple back in the 1980s. What vision for Apple going forward do Tim Cook and the board have that will surprise and delight not only the faithful but others who now have no interest in Apple?
7. Will a return to growth rescue AAPL? Robert Leitao of Posts at Eventide and founder of the Braeburn Forum argues so, in his recent article on Seeking Alpha and at his own blog in Apple: Net Income Growth Is The Name of The Game.
I would argue against that viewpoint. Apple can grow earnings with a new product and cost costs. General Motors (NYSE:GM) did that several times on its way to bankruptcy. Many other companies have done that as well. I would argue that Apple needs important new products. Otherwise it looks as though it has become a version of Microsoft but with Bill Gates dead. Apple simply looks as though it is drifting, living off of the ample seed corn that SJ era 2.0 left it. Because the remaining feed was so ample and the image so bright, too many investors have underestimated the possibility that the new team will not come close to accomplishing what Team SJ accomplished.
Given how many hundreds of billions of dollars over book value AAPL trades at, and how high its profit margins are in a very deflationary field, Apple needs rapid growth again to be better than an average stock.
8. However, most of Apple's current business lines are either declining (iPods, computers per se) or not growing fast any more (iPhones and iPads) though they are growing. Other product lines such as e-payments are dreams. One more deflationary force in smartphones and iPhones will start acting like Macs and may start showing no revenue growth sooner than expected.
In finalizing this article, I came across AAPL bear Michael Blair's latest AAPL article, from which I quote:
I have used my crude model of Apple's economics from its current products to ballpark what that might mean in terms of 2017 sales and net income. To do that I have assumed Apple sells 20 million Mac PC'S at an ASP of $1,250; 80 million iPads at an ASP of $400; and, 100 million iPhones at an ASP of $550. I have projected other revenues from software and service etc. at $30 billion continuing its double digit growth path...
The result is an Apple 2017 income statement showing $142 billion in revenues and $23 billion of net income or about $26 a share based on 875 million shares outstanding...
...you might see Apple trading at $350 to $400 before long.
I actually think that in such a scenario, the iPhone could have much lower ASPs, and earnings could at least for a while drop below $26/share. Thus in this sort of scenario, I think that AAPL could drop by half from the current price -- even though a reflex rally may well be overdue right about now given how much AAPL has underperformed the average stock very recently.
9. What has Apple's board contributed lately? I have been critical of Apple's board for some time. I think it grew to trust SJ so much that when he became very ill, it had grown complacent. I'd like to see an activist board. Tim Cook and company need to be held responsible for bring real innovation again to Apple. It's not good enough to live off of Steve Jobs' vision things.
10. Relative values favor other stocks over AAPL: Given the many different ways equities can be assessed, it appears fair to simply say that many other stocks have better price action and earnings trends while also having reasonable valuations, as AAPL can be argued to have. In my view, AAPL is not "safe" to buy on downtrends; and if it were, its upside would by the same token be limited and thus there would be little reason to bother to buy the dip.
I have a diverse portfolio of growth industrial stocks such as Trinity Industries (NYSE:TRN), which I have written about on Seeking Alpha at much lower share prices, energy stocks, tech stocks, and income stocks, and out of these dozens of stocks, I do not miss not having owned AAPL since early last year. While lacking foreknowledge of what's coming next, AAPL continues to look like yesterday's hot story without follow-through. The examples of companies such as DIS and many others that peaked in one era but did not get hot again for perhaps 20 years makes me cautious in assessing if and when Apple will get hot again.
Conclusion: I stand not with any short-sellers of AAPL but instead with the large group of independent thinkers who see little current attractiveness in this former high-flyer. I have written half a dozen review books for standardized tests; AAPL strikes me as a distracter stock choice just as multiple choice questions often have distracter choices. The company is of course a very strong company, but everyone knows that, and the bears have good arguments as I hope I have demonstrated above. (In this article, I have deliberately avoided making the bull arguments, because we are all familiar with those as well.)
My style is to own undervalued companies which show evidence of turnaround action, either fundamentally or in the marketplace. AAPL may or may not be undervalued, but the action of analysts and of the stock price provide little evidence that a durable bottom in either earnings or the stock price has been reached.
AAPL is therefore an easy stock for me and many other investors to omit from a diversified portfolio of common stocks.
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. Not investment advice. I am not an investment adviser.