Apple (AAPL) has become one of those stocks that have been hard to understand on a valuation basis lately. While many other stocks such as cloud companies NetSuite (N), F5 Networks (FFIV), and Salesforce.com (CRM) are hard to rationalize because their valuations are so high, Apple stands as an anomaly that it is hard to rationalize because its valuation is so low. The company enjoys roughly 45% annual revenue growth while more than doubling its earnings each year. Yet the valuation still stands at 15X trailing P/E even with the recent run in the stock. By comparison many of the cloud companies, including the ones mentioned above, grow their revenues at only around 20% annually while they continue to post losses in many cases. The valuations on those companies are so high that it has become meaningless to value them on a P/E or cash flow basis. They are therefore valued on revenue multiples, which is a questionable way to value a company to say the least.
So why the discrepancy in the valuation models? The obvious answer is the market cap. No matter the earnings, it just isn't that easy to push up a $450B market cap even further. As the market cap starts to get denoted with the "trillion" mark next to it, you run into a lot of psychological barriers too. However, there are some additional reasons, in my opinion, that Apple fails to reach the valuation level it deserves. While recent investor attention has turned to various products in Apple's pipeline, I would like to comment a little on these so called obstacles to further appreciation in Apple's stock.
While I remain tentatively bullish on Apple long-term, one of those obstacles in my opinion is the violent price action to the upside in recent months (roughly 52% in three months). In such tremendously large and widely held companies, such violent moves just aren't welcome news, even if they are perfectly rational on a valuation basis.
One of my main trading techniques when managing my own funds is to try to take the opposite side of a trade when a large-cap stock makes a fast and oversized move, even if there is a catalyst behind it. I will admit that it is a lot harder to spot such reversals when the stock is on its way up. The price action might seem exponential on one graph, but might seem perfectly normal on another graph with an adjusted price scale. However Apple's recent price action seems quite wild even with some adjustments to the price axis. While such moves might not affect the long-term holders, it definitely raises a red flag for the short term traders as it is hard to resist taking some profits after such a steep run.
Speaking of the long-term holders, there was another red-flag in the price action on Feb 15th, 2012, as the stock experienced a strong intra-day reversal on the scale of around 5%. While I can only speculate, it is highly possible that the price action on that day was the result of a major long-term investor reducing its position in Apple rather than a fickle hedge fund or a speculator. In my opinion, the reversal on that day signifies a rather broader problem with this stock. The issue is that, some long-term investors or the ones who bought substantial positions in and around the financial crises have made such large profits on this stock that it has become almost a necessity for them to realize some profits to secure their earnings. The temptation to take profits becomes even stronger, when the stock makes a quick run to the upside as it has done recently.
Another cause for concern is that Apple's recent quick move has come on the back of a rather unusually large outperformance of the general tech sector. It is important to note that although the tech sector is obviously dominated by high-beta stocks, the size of outperformance is still quite large even adjusting for that effect. Similarly, while Apple has enjoyed bursts of optimism and appreciation quite regularly, the recent size of the move, even in percentage terms, is also quite large by even Apple standards. It is a legitimate concern that no matter Apple's performance as a company, a reversal in the general market sentiment towards the tech sector might cause quite a shock in the short-term.
In the presence of these short-term risks, investors might want to wait a little for the stock to consolidate before chasing the stock.
There are also some arguments on the bullish side that Apple is even more undervalued when you back out the cash balance. That argument might be true for an investor who would take a controlling stake in the company, but it might not be so for small stake holders. I plan to address this issue in a little more detail in another article.
Also a detailed analysis of the mechanics of Apple's growth indicates that the Company might be finally reaching maturation in its growth. I will try to get into more detail about this in another article also.
These two issues, while not detrimental to further gains in the stock, might explain the investor sentiment, if the stock starts to move from investor darling to "great company but lacks the hype" category such as IBM (IBM) or Cisco (CSCO).
Additional disclosure: I have a long position in AAPL Mar 16th, 12 465 Put Options and IBM Mar 16th, 12 190 Put Options in the Portfolio/ Tech Opportunities Fund.