Apple Priced for Perfection: Great Company, Bad Investment

Apple (AAPL) is an example of a stock that is priced for perfection. The expectation for Apple's stock is so high that a purchase of its shares at these prices is more of a gamble than an investment. I keep reading about how the stock is going to $200, or that EPS estimates are too low. But with so much euphoria about the company and its stock, there is no margin for error.

I'm not saying that the stock is not going to $200. But let's slow down for a moment and take a quick look at the numbers. I'm using Georges Yared's estimates for Apple that go through FY 2009. According to his estimates, Apple's EPS will increase 20% from FY 2007 to FY 2008, and EPS will increase by 25% from 2008 to 2009 (using the high end of his range). Even at the current price of $137, Apple will have a PE of 23 at the end of FY 2009. A PE of 23 is not a bad number, especially if Apple can keep growing earnings respectfully, say 12% to 15% per year. But if, as predicted, Apple's stock goes to $200, the PE becomes 34. That's rather rich for a company that will have a market cap at that time of $173 billion.

For Apple to command that kind of PE, they will have to keep selling a lot of iStuff. Keep in mind, too, that Apple is primarily a consumer electronics company, meaning they are at the whims of changing consumer tastes.

If you've never read or heard of Ben Graham's parable about Mr. Market, I highly encourage you to take a minute and read it, or re-read it. Mr. Market's enthusiasm for Apple's stock seems to be growing daily, and as his enthusiasm increases, he's losing site of the fundamentals of the company, itself. Remember, all businesses have cycles, and when sales slow -- even a tad -- at Apple, the stock will be punished if traders and investors keep the notion that Apple can do no wrong. It's interesting to note -- and a reminder of how the fortunes of companies can and do swing back and forth -- Michael Dell's 1997 comments about Apple. When asked what he would do to fix Apple at that time, he said, "I would shut it down, and give the money back to the shareholders."

Apple is a great company, and Steve Jobs has done a tremendous job of turning around the company after his return as CEO. But as Warren Buffett says, even good companies make bad investments if purchased at the wrong time.

AAPL 1-yr chart

Disclosure: I have no positions in Apple.

Comments

[drinkpen]

All the buzz about "1 million iPhones sold" seems to be a huge over-estimate.
Apple and AT&T have been silent - do they have a good reason for silence?
All the availability/non-avail... at locations might represent redistribution, not sell-outs and restocking.
If the real number comes out less that 150,000, there might be real punishment.

[Tom B]

150,000? I don't think so. It'll be near a million.

[awcabot]

Mr. Yared predicts Apple's earnings to grow 20-25% in the next two years. This for a company that has had earnings grow in FY2006 by 48% and triple digits in 2004 and 2005. For a company that had sales grow about 35% per year in the past three years. It seems that Mr. Yared has a lot of explaining to do.

And I would not base any decisions from what seems an arbitrary earnings forecast.

[Jon T]

Wait for the 25th July announcements...

Apple may well be turning out to be a combined Microsoft and Sony..albeit one with better ethics and behaviour.

Judgements on calculating an Apple Inc. valuation may not be showing up yet in the "Investors Manual"!

[samij]

Everybody seems to estimate 550,000-750,000 sold during the introduction weekend and to predict 1.1-1.5m iphones sold by 25.7.. Anything less than million by then will be a huge dissappointment, either the initial estimates were way off, or the selling is slowing down even more rapidly than predicted.

If the sales were at 550,000 during the first weekend and there will be 1.1m sold by 25.7. the sales are slowing down by about 1%/day. This would imply less than 2m iphones sold by end of 2008, even including the potential of the selected European markets (UK, Germany, France).

[Tom B]

Back to school purchases; Christmas purchase; introduction in Europe; Network effects-- you see you'r buddy's iPhone and suddenly decide you need one. There are lots of factors that could accelerate sales. I don't expect it will be simple mathematical function.

Nor do I expect competitors to be able to launch a successful response. Ever. They'd be starting from ground zero. They'd need to write a whole new OS out of whole cloth. They are starting with less relative capability than the MP3 player makers had when they preceded Apple to to music player market. (MP3 players basically just have to play MP3; ultra-smartphones have to incorporate tons of sophisticated features--GRACEFULLY. To my knowledge, none of Apple's phone competitors even have a solid web browser at this point).

[John Lazerow]

CPU sales are what will drive this stock in the near term. I have been hearing too much anecdotal evidence that they are blowing away numbers in the most important part of their business. This is simply an awfully constructed article that pulls one earnings estimate out of the air and runs with it. iPhone will have little financial impact until Apple steps up distribution, i.e. Europe, Asia, etc. We will also see the true power of the iPhone business model once carrier payments to Apple are disclosed. I would say Apple is priced to growth not to perfection.

[Hayweed]

Still you have to look at AAPL from the standpoint that the earnings released in January were blow out and the stock jumped from 95 to 98 and then sank into the low 80's. Now all that is forgotten but my money is on the usual AAPL conference call where they underpromise future growth. I doubt they will release much iPhone info on salessince only 2 days were in the quarter. Also they intend to show the sales over a 2 year period which knocks some short term profit from earnings in the short term while helping long term growth.

I am a seller of most of my shares bought at $120 around the middle of June. 20 points in a month or about 16% is a nice gain which I prefer to take and not risk to the whims of the earnings game.

[RichardAlvarado]

You do understand that Apple sells more then consumer products right? no. ok then you underestimated APPL, therefor it is not price to perfection.

[frankz00]

Uh ohhhh.... looks like it's hater season again. The problem is that you haters have been wrong for the past 5 years consecutively. We already know how this movie ends!

[peter02l]

It's not a gamble when you compare Apple's Price/Earning to that of Research In Motion. Do you think RIM's growth potential after iPhone release is better than Apple's? At least Apple has several other products to fall back on.

[Camden]

Re: "especially if Apple can keep growing earnings respectfully, say 12% to 15% per year."

12% to 15% ???

With Apple's current product lineup and it's potential for upgrades, I'll be astounded if Apple's EPS growth is not over 30% in both 2007 and 2008. Mr. Edwards just can't seem to get his mind around a company of this size being innovative in it's core markets and moving successfully into new markets at the same time. Perhaps it hasn't happened before – but it's happening now.

[Camden]

Hey Mr. Edwards! Are you aware of Apple's earnings growth the past four quarters? From June 2006 to March 2007 Apple's quarterly earnings increased 46%, 68%, 75%, and 85% yr/yr.