I decided to take a look at Apple (AAPL) with talk of the stock trading under its 200 daily moving average one of the few times in its recent history. I thought there could be something changing in the industry that everyone else has been missing. Just like with any other stock, I went through the industry drivers, the financials, and the growth outlook. I came up with the same conclusion everyone else has: Apple is worth significantly more than it is trading for today. The smart phone market is growing at tremendous rates, the tablet market is projected to grow at fantastic rates, and Apple has the premier product in both categories. Apple’s first product, the Mac, is also growing at a pretty good clip. Apple has services that help add value and integrate its offerings: iTunes, iPhone apps and iCloud.
Apple has the free cash flow (FCF) to back up its stock price. Since 2003, the slowest rate FCF has grown on a per share basis was 19% y/y. Apple routinely puts up 50% y/y FCF growth and sometimes even 100% plus. Backing out cash on the books, Apple is trading at less than 10x trailing 12 month FCF. That’s implying that Apple will growth at GDP-like growth rates. You don’t need to be a rocket scientist to know that is simply way too low.
The fundamentals and industry trends are definitely in Apple’s favor, short-term, medium-term and long-term. However, Apple is going to have to continue executing on financial performance and product excellence. And just because we don’t see a product that will hamper Apple’s dominance, that doesn’t mean that something will not be introduced that won’t. The risk of technical obsolescence is large, although we won’t see it until it’s too late.
Examples of technical obsolescence are around us every day. For example, the iPod made the portable CD player obsolescent; DVDs put VHS cassettes out of business; digital cameras have nearly put film cameras out of business. Don’t get me wrong, I am not trying to imply that Apple is finished or that something will be invented soon that will put Apple out of business, I just think that this is the one risk that no one mentions when talking about Apple.