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Summary

  • Management is using the direction of business fundamentals to move the stock price in the same direction, setting in motion a self-reinforcing process in Apple stock.
  • Perceived as offering an asymmetric payoff, any growth catalyst will accelerate this self-reinforcing boom.
  • Apple stock is now at fairly-priced levels.

Apple (NASDAQ:AAPL) had its best day in more than two years after the company reported quarterly earnings that were much better than analysts had expected. Expanding the shareholder capital return program echoes management's confidence in stock's valuation, reinforcing the multiple expansion narrative as well. By announcing a seven for one stock split, management is trying to shift the stock ownership toward less sophisticated individual investors and create more liquidity in the stock. In my opinion, the expansion of the capital return program combined with strong business fundamentals, increased investor participation and a growth catalyst (if announced) will form a feedback loop leading to a self-reinforcing "boom" phase in Apple stock again.

Three major product categories (iPod and iTunes, iPhone and iPad) launched by Apple in the last 10 years have enabled the company to grow its revenues from $5.3 billion in 2001 to $174 billion in 2014. Earnings per share grew from $0.36 in 2004 to $43.25 (expected) in 2014. These are historic, unprecedented numbers for a growth company. What is truly astounding is that as the revenue and earnings shot upwards, so did the volatility in the stock price (using high -low price range). You'd expect to see that kind of volatility in a small start-up company, not a tech giant with $37 billion in profits.

Exceptionally strong business fundamentals which allow substantial free cash flow generation has served notably in formulating the market participant's bias toward this company. As Apple celebrated one success after another, participants continued to adjust their growth expectations in Apple's earnings multiple. In an earlier article, I contested declining growth premium as the prime element behind Apple's low valuation multiple. The lower valuation multiple serves as the central anchor in an investor's assessment of the company, who have been calling for convergence of this valuation gap with the rest of the technology sector. Massive share buybacks will boost the earnings per share higher, reinforcing multiple expansion propositions, but it doesn't signify any increase in the underlying performance or value of the business. However, this proposition by management will certainly influence investor understanding of the company, validating the investment community belief in the valuation of Apple shares. One major collateral repercussion will be the rise in participant expectations of an asymmetric payoff. These readily observable events are in fact an attempt to use the market prices as a projection of the fundamentals and thereby manipulate the prevailing expectations using these fundamentals. Additionally, these programs have given the company time to reignite growth with new products which Tim Cook reiterated during earnings call as under development.

Apple also announced the 7 for 1 stock spilt during its earnings release to broaden the company's stock appeal to individual investors. Lower price per share now would give access to a larger portion of the market and will also spur investor confidence. Management is using financial engineering tricks to exult its performance over the past several years and communicating the future prospects of the company. In reality management is attempting to capitalize on the psychological shift and broadened investor base, enticing them toward another huge gain opportunity.

Using the direction of business fundamentals to move the stock price in the same direction will set in motion a self-reinforcing process. Any upward revision to operating income growth expectations through introduction of new products will bring in a reflexive element to this process. The strength of the company's fundamentals, massive shareholder capital return program, mutual interaction between the underlying trend and investor bias will lead to a divergence of reality from actual fundamentals

My fair value estimate for Apple hasn't changed after the recent earnings release. Recent price action has led to the convergence of intrinsic value with the stock price. I think it's right time to speculate on a long position in Apple. I continue to believe that above mentioned management actions and their consequences have marked the beginning of another bull run in Apple. I continue to stay long in Apple through options markets. Having said that, investors should continue to look out for the build up of risks as expectations and reality divergences reach an extreme.

Source: Apple Moving Toward Another Bubble

Additional disclosure: Long AAPL through options.