Don't Let Apple Be 'The One That Got Away'

Oct.24.11 | About: Apple Inc. (AAPL)

Remember the time when you dated someone with whom you connected on every level? (Bear with me on this analogy.) I've often described using AAPL products like being "in love" - it's intuitive, and it just works. Unfortunately, sometimes dogma and meddling parental, social or cultural differences can place doubts and strain on what could be a beautiful courtship.

Sleepless nights, angst, doubt, pain, anger, the blame game, confusion - you name it - over-complicates what should be a wonderful thing. You end up asking yourself, "why me?" and "why us?" The radio seems to be only playing sad songs (like reading articles that are mostly pro-AAPL to make you feel better).

How does this relate to AAPL? Given the stock's reaction after reporting a blowout quarter to end the year, it sold off ($393 at time of writing), as it failed to meet consensus expectations.

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Given AAPL's consistent earnings, growth profile, reporting transparency, and disruptive products that sell, I know we are asking ourselves:

1. Why isn't it trading better than other large cap names, like Google (NASDAQ:GOOG), Amazon (NASDAQ:AMZN) or IBM (NYSE:IBM)?

  • How do you really classify Apple? Does it belong to "computer hardware" makers? or Software? or Telecom maker? or Retailer? or Video rental?
  • How does Wall Street classify Apple? There is no consistency between houses on what comparables they are using - I've got 3 reports from different analyst using different set of companies to compare AAPL to.
  • How can AAPL trade like Nokia (NYSE:NOK)? Is Research In Motion (RIMM) undervalued and AAPL overvalued, or vice versa?

I've got news for you, and you won't be happy with what I have to say. To expect AAPL to trade better than its peers is a losing proposition. We can only expect Apple to do what it does best - create beautiful, disruptive products that just work, execute flawlessly, and offer transparency in information.

I suggest that one should value AAPL against AAPL itself, while keeping in mind the fundamental metrics of other companies you think are comparable within the market it competes. For my own sanity, I tend to use GOOG, AMZN, Microsoft (NASDAQ:MSFT), RIMM, Dell (NASDAQ:DELL) and NOK (to a lesser extent) as my frame of reference.

To put things in perspective, AAPL just guided towards a $37B quarter. Find me another tech behemoth with comparable market cap that is growing like that quarter after quarter!

2. When will it ever trade like its peers?

Based on the above (and the fact that no analyst has understood AAPL correctly over that past 5 years), I can safely conclude that it will never trade with a meaningful premium compared to its peers.

Here and here I proposed some hypothesis on why there may not be an end in sight regarding Apple's P/E compression.

3. What can AAPL management do to help raise its stock valuation profile?

Reverse-split the stock to reduce the float! (Just kidding.) AAPL only cares about meeting its own expectations and those of its customers. It has never cared about what the Street thinks (kinda weird that Steve Jobs would rather ask MSFT for an investment than go raise funds with the big houses!). Unless this has changed under CEO Tim Cook's leadership, nothing will change.

Stock splits - compare Apple with the other large caps (albeit with lower growth profiles) that have split their shares (Cisco (NASDAQ:CSCO) or MSFT comes to mind); it hasn't made any difference in the stock's absolute returns over time. A $10,000 portfolio made up of AAPL will still buy $10,000 worth of AAPL shares, regardless of whether they're at $400 or $40.

Buybacks - Same as above. As I've written before, I haven't seen any compelling proof that it would work. I'm a firm believer that cash, when used wisely, allows you to dictate terms. Dividends - AAPL, without dividends, has outperformed tech stocks that do pay dividends. How does that compute?

4. How will you make money over the long run if AAPL continues to be misunderstood and mispriced?

These types of pullbacks merely represent opportunities to add to your position. What AAPL instrument you choose to trade really depends on your own resource, tolerance, and time horizon.

Given that AAPL has indicated Q1 will be healthy, my current plan is to be adding ATM leaps any time it drops to the $370 level (purple dashed lines) and sell them as the stock hits the black dashed upper channel. Barring any epic financial turmoil in the next 3 months, another earnings run is almost assured. Given my concentrated position in AAPL, my main emphasis will always on reducing my cost base.

5. You cannot eat, drink or fuel your vehicle with the products it makes. This growth cannot go on forever, especially in the current financial chaos!

Finding and staying in a great relationship requires work, and the path isn't linear. It requires effort and the ability to keep promises all the time.

It is true that the product AAPL makes can be dismissed as non-essential. But have you ever tried taking an iPhone away from your wife, girlfriend or kids?

Given that we can only connect the dots looking backwards, I'll deal with this concern with facts that I know. I'm only going to use the iPhone here as an example as it represents the biggest revenue and profit contributor right now. The facts are:

  • Current world population is 6.97B. Asia has 4B while North America has 352M.
  • Worldwide mobile phone users hit 4.6B in 2010.
  • iPhones (including older models) only account for 146M of the 4.6B mobile phone market. See the chart below.

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Will all mobile phones be smartphones? I highly doubt it, but even using today's smartphone user subset of 1.5B users, the opportunity for AAPL continues to expand. Just like we dismissed the disruptive nature of the iPod, it is easy to dismiss the disruptive nature of the iPhone and the iPad unless you have used one yourself.

AAPL cannot guarantee the future; it chose to build it. We can only judge it by its actions and promises. Here is a company that delivers time and time again, but we seem to nitpick it. On the other hand, we complain about how corrupted our world is and wish other companies would grow as much or would be as transparent.

Keep in mind I haven't dealt with the iPad. This is the first time that AAPL has 3 disruptive products that transcends age, race, culture and market segmentation (i.e. business or consumer). The iPod has also been dismissed; I'd beg to differ - it is the perfect incubation tool for future AAPL users. Have your kid use one - and say goodbye to Nintendo DS and PSP - those are "so yesterday," as they would tell you.

Like in any relationships, asking why you got into it in the first place allows you to find peace during uncertain times. Apple knows why it is what it is. Do you know why you bought it?

Most of us have been in fantastic and meaningful relationships that we, in hindsight, wished we never left. I'm sure there are shareholders thinking of leaving due to this miss; will they listen to the noise and look back one day that they let a good one get away? Regret always comes at last.

A side note: I've tried the voice recognition on Android and compared it to iPhone's Siri. Siri is it - it gets it. Granted, Siri needs some time right now to find her way (beta), I still believe that with Siri, Apple is again building its future. Like the iPod, iPhone and iPad, we just don't realize its disruptive potential.

Disclosure: I am long AAPL.