Stock Stress Test: Apple Looks Fairly Valued

Sep. 6.11 | About: Apple Inc. (AAPL)

U.S. investors find themselves bracing for battle Tuesday with S&P futures down sharply following a massive sell off in Europe Monday. Leading the move to the downside were European banks hit hard on the heels of suits filed by the Federal Housing Finance Agency against 17 of the world’s largest banking institutions.

A debate for the Republicans on Wednesday and a speech by the President Thursday will only add to the confusion as the rhetoric will be focused on positioning for the election. We know that. Investors are in the acceptance phase and now understand that their government won’t do their job and therefore can’t help them.

In an economy that is flying close to stall speed we need strategies designed to work in a slow growth or no growth environment.

Market Timing

This of course seems like the obvious solution. Just side step the cracks and step out of the market when they turn on to I-95 South and jump back in when the crisis has passed. Easy?

A word of caution. You better be good at this. I mean really good and consistently on the right side of the trade. An unsuccessful market timing strategy can turn into a weapon of mass destruction quicker than you can say fibonacci. To be a successful market timer you need a batting average greater than 700. Remember that market timing is a two decision process. You have to be successful on the entry and the exit. If your entry is right 70% of the time and your exit is right 70% of the time your strategy is only working 49% of the time. .70 x .70 = .49 (Statistics 101)

If you are going to de-risk, option hedging and long/short strategies will produce better long term results than an all in all out market timing system. If you have developed a market timing system that consistently gets it right than by all means Lock and Load. If you are still here with the rest of us mortals than listen up. It’s time to send your stocks to school and make them take a test.

Stress Test Your Stocks

If your stocks can't pass this simple test, kick them out. Most portfolio managers use models or factor analysis to make individual securities selections. Every investor has their favorite factor. Price / earnings, price / sales, PEG ratio, estimate revisions etc. are all factors we look at every day. For quantitative managers the list could be 50, 100 even 200 factors to screen that determine whether a stock is going to make it to the finals of the beauty contest.

Value and growth managers use similar data points, however beauty is in the eye of the beholder. The value manager may be focused on low price / earnings or price / book ratio as the most important attributes while the growth manager might be fixated on sales and earnings momentum. Let’s look at one example.

AAPL Stress Test

Apple (NASDAQ:AAPL) - Since I am writing this on a Mac Pro and this is perhaps the most popular company on the planet it seems like a good choice.

First part of a stock stress test is giving all the numbers a haircut. The spread sheet below contains the current consensus numbers for Apple, courtesy of Reuters.

Using the above consensus estimates, Apple looks pretty healthy with top line growth of over 20% and a healthy bottom line growing at 17%. If that 32.07 holds you are looking at a forward PE of less than 12. I’ll take that all day long. Now, can AAPL pass the stress test?

Digging Down Into The Numbers

Ok, let’s take those 2012 numbers and give them a 10% haircut. Now the spread sheet looks a little less attractive.

The growth rate has come down quite a bit but the top line is still growing at 10%. In a no- growth economy that doesn’t look too bad. Bottom line is still growing, but with earnings cut to 28.86, growth is now in single digits. At current prices and a 10% haircut, Apple looks fairly valued and would probably rate a hold. Of course the numbers look a lot better if you take out the cash, but I’ll leave that up to you.

Do yourself a favor. Put your portfolio through an exercise like this and let the chips fall. If your positions don’t pass muster than eliminate them without emotion. Remember HOPE is NOT an investment option.

Disclosure: We are currently long AAPL in our Alpha Select Accounts at Belpointe Asset Management.