Is The Smart Money Getting Out Of Apple?

| About: Apple Inc. (AAPL)

Before Tuesday's rally, shares of Apple (NASDAQ:AAPL) had been underperforming lately despite the market holding up quite well. Recently, Jim Cramer has said that Apple is no longer an asset class, it's just another [good] stock. When Cramer turns mixed on Apple, a crowd is surely to follow. On October 19, the day after Apple reported its latest quarter, the stock closed at $398.62. Apple has lost about 4% since that day, while the NASDAQ is up about 2%. Apple shares have not traded well lately, leading many to fear that the next level of support could be the 200-day moving average, which currently is about $363. One may start to wonder if the stock is just taking a breather, or this is a sign of something bigger. Could the smart money be getting out of Apple? Let's take a look at some issues right now.

Amazon's (NASDAQ:AMZN) Kindle Fire: Is this the iPad killer? It could be. From all reports, the Kindle Fire is doing extremely well in sales, despite Amazon probably losing money on it overall. When Amazon reported its latest quarter, the midpoint of the revenue guidance for this quarter was $17.55 billion. Analysts were slightly below $18.1 billion, and now they are at $18.14 billion. The bigger tell is EPS, which has come down from $3.20 to $2.07 to $2.05. Every time I see EPS numbers lowered, I'm thinking that revenue is going higher. And that's your Kindle Fire right there.

Last week, an independent research firm cut its iPad estimates for the quarter, citing competition. Amazon doesn't mind the Kindle Fire being an overall loss because it feels it will make the money up when people purchase e-books or other products on its site that it makes money on. Amazon is also getting into the cloud business, taking another stab at Apple. In fact, since Amazon's day after earnings drop, the stock has rallied 10% compared with Apple's 4% loss. Despite its lofty valuation, people seem to be favoring Amazon right now over Apple.

Concerns with Other Products: Mac sales are doing extremely well for Apple, but that's not its only product. There have been concerns over the latest iPhone, with speculation that Apple has cut orders for it. CNBC said this morning that Samsung's Galaxy S has been a bit hit, and that it could give the iPhone a run for its money. I think that's a bit of a reach, but the competition is getting better. Also, last quarter's iPod sales were well below street expectations. Given that year-over-year sales are down to begin with, missing expectations only worsens things. The iPod's relevance may soon cease to exist.

Sector Rotation: Could investors be selling Apple and shifting their focus? Take a look at two names, IBM and Cisco (NASDAQ:CSCO). IBM's latest earnings report caused the stock to decline a bit, but the company has rebounded nicely and erased those losses. Yesterday's news that Warren Buffett has bought over $10 billion of the name could attract more money to it. And unlike Apple, IBM does pay a dividend and is a blue-chip name in the Dow, so as times in Europe become even more uncertain, people may ditch the high-growth Apple for a blue-chip value stock in IBM.

Now take a look at this Cisco/Apple chart. Notice how Cisco has done much better than Apple recently? Well, Cisco did report a great quarter, and that gave some new life to a stock that some had previously called dead. It's not dead yet. Cisco also pays a dividend and is buying back stock. Apple is doing neither. This could be a bit of temporary sector rotation but it's worth noting.

Analyst Hype: If you ask people out there why Apple fell after its latest quarter, a majority of the people will tell you that analysts raised estimates way to high. I too was guilty of that, expecting a much better quarter than I should have been. Let's look at the following chart, which I've brought over from Yahoo! Finance's earnings estimates page.

EPS Trends 1Q 2012 2Q 2012 FY 2012 FY 2013
Current Estimate $9.73 $7.83 $34.54 $38.63
7 Days Ago $9.70 $7.82 $34.49 $38.56
30 Days Ago $8.98 $7.52 $33.05 $37.92
60 Days Ago $8.72 $7.41 $32.39 $37.03
90 Days Ago $8.68 $7.40 $32.12 $36.88
Click to enlarge

Now we know that Apple usually gives conservative guidance when they report, but they were projecting $9.30 in earnings. That's up about 45% over last year's quarter, while revenue is only currently projected to rise 42% (38% based on the guidance). And remember that this quarter is 14 weeks versus last year's 13 week quarter. I've been watching this chart every few days, and the estimates keep rising. Analysts could well be setting up Apple for another miss, which would be unfortunate. We still have another two entire months until Apple reports quarterly results, so I don't think it's out of the question that EPS estimates could be over $10 by then. Just look at how this EPS rise has affected the P/E.

P/E Multiple Price FY 2012 FY 2013
Current $379.26 10.98 9.82
7 Days Ago $399.73 11.59 10.37
30 Days Ago $422.00 12.77 11.13
60 Days Ago $392.96 12.13 10.61
90 Days Ago $380.48 11.85 10.32
Click to enlarge

Apple is trading below 11 times fiscal 2012 earnings (ending in September), and now is below 10 times on the 2013 number. While you might expect some P/E contraction given Apple's large size and maturity, keep in mind that the trailing P/E is 14. And that leads to another analyst issue, the price targets. If Apple did that $34.54 in earnings with a 14 P/E, that gives you a price of $483.56. But analysts' current target for Apple is $506 (and was $503 just a week ago). Some targets are as high as $700. Either Apple's EPS will be much higher, or the P/E is going to rise. I think the former is a bit likely, but I don't see a rise in the P/E. Not right now.

And I think this could lead to a similar situation that we've seen with Google (NASDAQ:GOOG). For a few years now, I've been hearing about analysts with $700, $800, even $900 price targets on Google. I'm still waiting. Google has not been above $650 since early 2008, yet the analysts continue to have such lofty price targets. Of 31 brokers currently involved, the low price target on Google is $645. That's 5% above the current price and the top of the range for Google's stock in over 3 and a half years. Google's shares have been up lately, but look at this chart. Every time it hits these levels, it drops back down. I feel Apple could be in a similar situation, and that means no $500 for a while, despite what analysts think.

Conclusion: Investing in Apple is a marathon for most, as it is in it for the long haul. I used to run 10k races (6.3 miles), and around mile four I used to get tired and need a breather. That could be the case with Apple here, as we are gearing up for the next leg higher. Given that Apple is now down 10% since earnings, it seems like an attractive entry point, right? It may be, but the issues above are slightly concerning.

So what needs to be done going forward? Well, I don't think analysts will stop raising their estimates, so that is out of Apple's control. Apple could cut the price of the iPad in an attempt to reduce Kindle sales, but I think that would hurt more than help. Since Apple doesn't usually make acquisitions, and not big ones anyway, that is not an issue. But with more than $81 billion in cash and investments on the balance sheet, a dividend or buyback might be the solution. I'd rather see a buyback now since Apple is still a growth company, but there might be a day where eventually Apple will pay a dividend. Look at all the tech stocks that now do.

I've been saying for weeks that if you can get Apple under $400, it's a good deal, and under $375 would be a great deal. One bad piece of news out of Europe or a problem with the US debt deal could get us under $375. Apple needs to report a good quarter in January to get back the luster it may have lost, or the cloak of invincibility may be gone forever. At that point, the smart money will be getting out of Apple, but I don't think they are currently.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.