I've been pondering something over the past few weeks, something enough to run chills down my spine. It feels like analysts who are creating estimates for Apple's (AAPL) earnings release on Tuesday aren't just creating them solely based on analysis, but somewhat based on topping off other analysts' predictions. As we have seen in the past month, analysts after analysts have increased their prediction on Apple's future earnings and stock price. At first, it seemed like something completely justifiable, until we started seeing four-digit predictions, like the infamous $1001 projection by Topeka Capital Markets. At this point, it became a game of who could have the highest estimate. Seriously, take a step back for a second. In order for Apple to justify a $1001 stock, its EPS needs to be around $60/share just this year alone; about a 72% increase from last years' earnings. To me, and hopefully others, this is beyond unrealistic and creates an area of concern, especially with the earnings report releasing this Tuesday.
I believe that analysts have become overly ambitious and feverish in their earnings projections, creating a troubling expectation for Apple to surpass. What I'm pointing to is that, under one month ago, the consensus EPS was around $9.50, but now it's at $10.00; about a 5.2% spike in projections, but this is during a time when market developments haven't seemed to support such optimistic claims. It's true that corporations have been bringing in record profits and we're experiencing very strong demand for Apple products, but can't it also be said that the expectations for Apple's earnings this quarter are just a bit high?
Their earnings last quarter was a record $14.03/share, but that was because of several unique factors. First, it was based off a 14 week quarter, compared to the normal 13 week quarter. Second, it was during the quarter of Apple's iPhone 4s release, which is Apple's largest profit driver, with a gross margin of about 75%. Third, and most importantly, it was during two of the largest shopping holidays of the year: Black Friday and Christmas. The current earnings estimate is at $10.00/share, on a 13-week basis, without the push of a new iPhone release. Sure, the iPad 3 was just released, but its gross margin is only about 42% of sales, and its demand is far less than that of the iPhone. Also, the iPad 3 was released during the last 2 weeks of the quarter, which will only marginally impact the overall earnings.
One thing to note though is that the iPhone 4s was released early January in China, during their Lunar New Year, which is basically Christmas on steroids; this will push up their earnings, but I'm not sure if it will be enough to push it beyond the very high expectations.
In analyzing Apple's earnings release today, I took a moving-weighted average approach to create a predicting value of future earnings based on the 12-month Q/Q increase in earnings. First, I did a quarter-to-quarter earnings appreciation comparison, tracking the percent increase in EPS over the past year by comparing quarterly earnings to those of its previous year. By doing this juxtaposition, I got the following values:
- Q1 2012/Q1 2011: 116% increase
- Q4 2011/Q4 2010: 52% increase
- Q3 2011/Q3 2010: 36.5% increase
- Q2 2011/Q2 2010: 92.2% increase
From this point, I assigned weights onto these values; placing the greatest weights on Q1 2012/Q1 2011 and Q2 2011/Q2 2010. My reasoning for this is that I believe a very strong indicator of future earnings comes from a two-fold approach: viewing the most recent earnings and also the previous Q/Q earnings of the same quarter. This allows us to put a stronger emphasis on earnings trends. I assigned a 40% weight to Q1/Q1, 20% weight to Q4/Q4, 10% weight to Q3/Q3, and 30% weight to Q2/Q2; in doing so, I calculated a weighted moving average of 88.11%. This should give us a general estimate to be used solely as a guideline for making a buy/sell decision now regarding today's earnings release. Applying the 88.11% weighted-moving average to our previous quarter's EPS of $6.40 will bring us to an EPS of $12.04.
My overall consensus is this: Apple may or may not beat its estimates, but regardless of that, we will see a very strong overall report. If Apple does not meet its earnings, it's not because Apple underperformed, but because investors expected too much. This may lead to a sell-off, at which point would create a very strong buying opportunity for long-term investors. Keep in mind though that if Apple can beat the expectations, those who did not invest prior to the release of the financial report will miss out on large gains. My strategy to overcome the dilemma of buying now or waiting till the financial report release is this: hold onto some Apple shares now and keep cash available for investment on hand. If Apple does not meet its expectations and the stock drops, you can use this available cash on hand to reap the benefits of this sell-off, rather than putting all your eggs in one basket and suffering financially. If, though, Apple beats earnings you'll at least have some money invested into Apple to reap the benefits of a likely rapid stock price appreciation, but will unfortunately miss out on some gains because of the cash on hand.
Disclosure: I am long AAPL.