Apple (AAPL) is perhaps the biggest anomaly on Wall Street. The company is the perfect turnaround story. It fought tooth and nail to claw its way back from the brink of market irrelevance in 1997 to become, to date, the most valuable company in the worId. It has crushed every competitor that has stood in its way, it's perfectly positioned to ride the explosive boom in smart phones and tablets, its balance sheet is an absolute juggernaut, and it's led by the best talent in the business. This is the rare company where no one has a bad thing to say about it. Out of the 42 analyst firms providing coverage on Apple, exactly none rate it a sell.
So why does the stock trade at a P/E of only 15? You won't find the answer by asking the investment community - you can hunt for hours and you won't find a single substantive bear case against Apple. In a discussion with SA readers and fellow Apple investors sean.parmelee and Dialectical Materialist on another post, we talked about how difficult it is to find any negative coverage on Apple to balance out the constant deluge of bull pitches. Apple has certainly earned the favor the investment community has been showering it with ... it's been making all the right moves for years. After all, that's why we're all willing to stake down our own money on the company.
So why do you want to read a bear case against Apple? Because clearly the big money on Wall Street doesn't like the company as much as we do, and it might provide a clue as to why. It's one thing to talk about how great a company is, it's quite another to actually put your money where your mouth is and buy the stock. Despite the exceedingly bullish analyst consensus, Wall Street isn't buying Apple. Sure, all the funds have a token position in the stock just so they don't look silly compared to their peers, but they're not buying it in amounts that would actually drive up the valuation. Since no one is talking, we can only venture a hypothesis, so let's hypothesize. Here are some of my best guesses as to why Apple isn't getting any love from the Street.
Steve Jobs Is Gone
Okay, let's get the most obvious one out of the way first. Apple pretty much was Steve Jobs, and many have doubts about whether or not the company can retain its competitive edge after it lost the man who brought it back from the brink of extinction in the first place. To be fair, Jobs isn't exactly gone, he's still serving as chairman of the board, but I don't think anyone is expecting him to stay on that seat for a very long time. Jobs' health issues have been widely known long before his official resignation. On the day that he stepped down, the stock actually beat the SPDR Technology Fund (XLK), demonstrating that the market has already discounted the question mark over Jobs' health.
I think a lot of investors are looking at Apple right now and remembering what happened to rival Microsoft (MSFT) after founder Bill Gates left the company. I don't share their fears - I believe that Apple is positioned for success even without its figurehead. Tim Cook isn't Steve Ballmer, and Apple isn't Microsoft. Furthermore, investors should remember that Microsoft's dismal stock performance over the past decade isn't exactly Ballmer's fault. The stock hasn't gone anywhere because it has been saddled with a massively inflated valuation for the large part of the decade, a burden Apple doesn't share. No doubt Apple has lost a tremendous asset in Jobs, but he's left behind a team that is fully capable of steering the company to greater heights than ever before.
Apple Isn't Very Shareholder Friendly
Even the most avid Apple bulls admit that if you're looking for a shareholder friendly company, you'll best look elsewhere. Apple has been a huge win for shareholders indirectly over the past ten years as the result of its unstoppable rampage to become the king of the technology sector. Depending on when you got in on the action, this stock could've been more than a 10-bagger for you. Still, the company hasn't done much to reward shareholders directly, unlike technology peers like Intel (INTC). Despite holding over $70 billion on its balance sheet, it has returned exactly $0 to its owners. All the money Apple investors have made so far has been from other Apple investors. Everyone can see the massive potential in Apple's future cash flows, but perhaps the Street isn't giving credit to Apple's earning power because it doesn't believe it'll be able to benefit from those earnings. SA author James Kostohryz believes that Apple's stock might see an upturn if the company adopted a more efficient capital structure.
However, I don't see the logic in this one either. For a retail investor, who doesn't have the voting power to influence corporate policy one way or another, it would actually make sense for him to avoid Apple if he has this concern. But for institutional investors, who do have the power to change things, they can easily vote for a dividend, a buyback, or whatever means for shareholder return they want. Management may make the decisions, but owners select the management. If Apple shareholders want a dividend, and I believe those that do have good reason for it, they should exercise their power as owners instead of waiting for management to spoon feed one to them.
A Clouded Crystal Ball
Now here's the explanation for Apple's discounted valuation that I personally find most credible. It's no secret that Apple likes to keep secrets. One of the reasons the company has been so successful is that it's laser focused and hyper efficient. Apple doesn't make many products, but the ones it does make tend to come out of the gate full speed, barreling over all competitors in their path. And the company doesn't tell the world what it's working on until it's ready to unleash the next revolutionary gadget on its unsuspecting consumers.
This is a great business approach, but it does mean that investors have a harder time visualizing the company's growth, since so many avenues of opportunity are unknown to them. We can only forecast Apple's future earnings based on the iMac, the iPhone and the iPad, its key revenue drivers right now. No doubt the company's engineers are already working on the next big hit, but since we don't know what it is, we can't credit Apple's stock with it. On the other hand, when you take a look at a company like Google (GOOG), who's got its hands in every pie, from search to social to mobile, it's easy to imagine how the company can make a lot more money in the future. Whether or not it actually will is not the point, but at least investors can see it.
What should be done about this? In my opinion, not a thing. As an investor, I prefer Apple's approach to Google's. I believe it's better to work on a few products and dominate their markets than to work on many things at once and succeed on only a few. Also, the benefit of secrecy is that it makes it much harder for your competitors to see you coming until you're right up in their face, and by that time it's too late. Take a look at the iPad: we're more than a year after the release of the original and competitors like Research in Motion (RIMM) and Motorola (MMI) are still playing catch up. Nokia (NOK) was the king of the jungle in the mobile phone industry before it got blindsided by the iPhone, and it's still scrambling for traction. Playing its cards close to the vest has been paying off big for Apple so far, and I wouldn't want it to try to fix what isn't broken, even if it means it'll be unlikely for me to see a large premium on my stock.
The Law of Large Numbers
This one isn't unique to Apple, large caps in general tend to sell at lower valuations than small caps, and Apple has reached the point where it's not just a large cap, but a mega cap. The anchor of size weighs down even the best companies eventually, though Apple's been hauling this weight around like it's nothing, consistently posting almost 100% year-over-year growth and crushing analyst estimates every quarter. However, it's clear that Wall Street doesn't believe the company can maintain this growth rate. Will Apple prove them wrong? Only time will tell. Former Google CEO Eric Schmidt identified the four leaders of technology in today's market to be Apple, Google, Amazon (AMZN), and Facebook. Facebook isn't publicly traded yet, so it's out, but when we take a look at the other three, it's obvious that their valuations are inversely correlated with their size. If Apple was a smaller company, I can guarantee you that investors would be much more willing to pay up for its earnings.
Investors who bring up the law of large numbers should bear in mind that Microsoft and Cisco (CSCO) had market caps of $600B and $550B back in 2000. Apple's story today is much better than either of those companies was back then.
So, Which One of These is the Answer?
I would say, probably all of them. None of these factors in isolation could sandbag a goliath like Apple, but put them all together and you might have a convincing explanation for why Apple isn't getting any love from Wall Street. Any other company with Apple's financials, Apple's brand power, and Apple's management would easily be bid up to much higher valuations than what Apple is trading at now.
Is this a bad thing? Not necessarily. Sure, as an Apple investor, I wouldn't mind seeing the stock more richly valued, but I would rather be holding a great company that's constantly selling at a fair price than a mediocre company that can be pawned off at a premium today. Cisco traded at a P/E of well over 200 back in its heyday. Investors eventually realized that they were wrong about the company's prospects, and the stock has cratered 80% over the past decade. Since Apple isn't benefitting as much from investor optimism, that also means it can't be hurt as bad if its story takes a turn for the worse and that optimism turns into pessimism. In the meantime, I'll just let the company's success carry my investment instead of having to rely on the always fickle enthusiasm of Mr. Market.
Disclosure: I am long AAPL.