I have been way too early in calling Apple's (NASDAQ:AAPL) fall, but I now stand as strong as ever in my claims that Apple's stock is on the verge of a significant and mostly unexpected drop.
Apple has carried the stock market for a few years now, leading indices higher as it continuously shattered earnings estimates and dominated markets. The market's rise owes much to Apple's strength, as AAPL has made up as much as 20 percent of the Nasdaq 100 (NASDAQ:QQQ). With such a giant weighting in the index (now still above 10%), as well as the S&P 500 (NYSEARCA:SPY), Apple is both a beneficiary of rising stock prices and a contributor to them. But with Apple reporting earnings this week, and with many surfacing points of weakness, the all-time top may already be in. Disappointing earnings or unhappy investors could trigger a large fall; but even if this week's earnings send the stock price shooting up again, the top is very near. A "trillion dollar market cap" will never be reached.
28 Big Reasons Apple (AAPL) Will Fall
- Parabolic price increases. The most visible sign of an overheated investment theme is the soaring price of a stock. Perhaps nothing has been more outstanding and tempting than the tremendous rise in Apple's stock. In fact, since its July 1, 1997, low of $3.16, Apple has risen nearly 20,000 percent! Having a stock rise 1,000 percent is amazing; having it rise 20,000 percent may be ridiculous, and definitely not sustainable. Understandably, Apple has been a Cinderella story and has earned its spot as number one company in the world. However, its stock is not only up hundreds of percent since the 2009 low, but has also soared at an extremely steep and unsustainable angle from December 2011 until early April 2012.
- Massive market cap. Apple used to be smaller than Microsoft (NASDAQ:MSFT), Google (NASDAQ:GOOG), and other top technology companies. It has since grown at such a rapid pace that it is currently more than twice as big as the second-largest tech company. It is the largest company in the world, and it is one of less than a handful of companies to ever break the $500 billion market cap mark. Such massive size gives Apple a lot of power, but it may also limit its growth potential, as it is much harder to grow what is already a mammoth. Companies that reach these stratospheric heights usually have a very hard time staying there.
- Relative value very unappealing. As I've pointed out before, based on market cap, Apple is bigger than many of the world-leading companies combined. There is simply just much more value and diversification - and much less risk - investing in a broad basket of industry-leading companies. (See: What You Could Buy For 1 (Very Overvalued) Apple)
- Rising competition. Apple has completely dominated personal media players (iPod), smartphones (iPhone), and tablets (iPad), but its period of domination is being challenged. Competitors such as Google , Amazon (NASDAQ:AMZN), Samsung, and a number of others are introducing enticing products attempting to dethrone Apple from its unreachable position. The competitors have a number of things working for them - from much lower selling prices, to different technologies, to changing consumer tastes.
- Extreme expectations (earnings). Perhaps most threatening to Apple's stock price, extreme expectations by both customers and investors could really hurt Apple as the failure to meet those expectations could send the price plummeting. Earnings have constantly shattered expectations, and investors have become a little too accustomed to massive outperformance and consistent growth. The time is approaching when investors are negatively surprised with disappointing numbers.
- Extreme expectations (price targets). Apple's stock has soared from under $100 in early 2009 to over $600 in 2012. The price rise has been remarkable, yet extremely steep. Such a rise is usually not sustainable and must correct. Moreover, with such a massive rise in both stock price and market cap, there is likely little left to the upside. However, that has not stopped most analysts from predicting that prices will still continue to rise. In fact, expectations have become so extreme that a number of analysts have now predicted that Apple will become the world's first trillion dollar company! Even more, one analyst has predicted that AAPL will hit $1,650 in three years. It is one thing to say Apple will rise another 10-20 percent, but to predict that Apple will nearly double or triple from its already No. 1 position is bordering on absurd.
- Disappointing earnings or guidance. The extreme expectations set Apple up for disappointment, as investors will no longer accept Apple just meeting expectations. Investors will only accept Apple beating estimates, and they will likely require a significant beat. If Apple fails to continue what it has been doing thus far, it sets itself up for a sharp fall.
- Stagnant products. Apple has continued to introduce revolutionary new products or new models of its existing products, but a failure to innovate effectively will hurt it in the future. The iPod, iPhone, and iPad are so dominant, but investors are expecting more. Investors are pointing to iCloud and iTV as perhaps the next phase of innovation, but their failure to catch on or truly dominate can really hurt Apple. Furthermore, even if Apple fails to update its existing products effectively it could fall. Investors are expecting a lot from the iPhone 5 and the "New iPad," but their success is not guaranteed.
- Product cannibalization. Is the iPod becoming obsolete? While the iPod is still the most dominant music player in the world, its benefit to Apple may be shrinking. With Apple's iPhone and iPad also providing the same music-playing capabilities, sales of the iPod may be cannibalized as customers buy the iPhone or iPad instead. The iPod is not the only product that may be experiencing cannibalization due to Apple's other products. The Mac computer sales are also being cannibalized by the iPad.
- Post-Steve Jobs era. Jobs left Apple with tremendous momentum and a great roadmap for the future, but the company has already entered unchartered territory in which it must make decisions for itself without his help. We've already seen Apple declare a dividend (would Jobs approve?), and its future strategies could also come into question. A rumored smaller iPad would be going against Jobs' warnings, and the loss of its top leadership could lead to Apple going in the wrong direction.
- Culture change. The loss of Steve Jobs and the massive growth of Apple also brings a new culture for the company. Apple is no longer the "cool" company that offered products which a smaller group of people could buy or afford; now millions upon millions of people own Apple products. Tim Cook, Apple's new CEO, is obviously much different than Jobs. And though he may be Apple's top leader, he is still no Steve Jobs. The culture of Apple has changed; customers and investors are no longer able to rely on Jobs' genius to lead the company. We now rely on momentum. You can bet that there will be some major complaining by customers and investors in the future.
- Fundamentals already priced-in. Investors have run up the price of Apple stock to such highs due to very promising and solid fundamental drivers: the company keeps growing revenues, new products are introduced, existing products are dominating, China is still to be conquered, and "much growth is still left". However, since investors are expecting so much of Apple, their expectations for continual outperformance and rapid growth is factored into the price. Essentially, investors are paying for the stock now what they think the stock will be worth in the future. And since they think Apple's future is so bright, the stock has soared past $600 and the company has been worth $600 billion. However, much of the expectations are included in the price, and the stock is therefore limited in upside potential. Apple will now struggle to meet investors' expectations, and it will not exceed them.
- Everyone knows about Apple already. The best investments are those which are not attempted by everyone, because if everyone tried the same thing it wouldn't be profitable. Therefore, those who buy the "hot" stock early benefit as the stock soars while they own it. Those who bought Apple early on have seen tremendous gains of hundreds or thousands of percent. Even those who bought the stock early this year have seen significant gains, with Apple up 45 percent YTD at one point. However, we have reached the point where every single investor, customer, hedge fund, and mutual fund knows that Apple is a "great investment". In fact, Apple has been the hedge funds' number one stock, and 84 percent of Apple stock is owned by mutual funds (and, in turn, the common investor). If nearly everyone who had the chance to own apple has already bought it, there is not much upside left.
- Forward PE very misleading. Forward PE ratios have been so low because expectations are so extremely optimistic. Many Apple investors have been using Apple's PE as a reason to buy the stock, since the forward PE is close to 11 or 12. Agreeably, 12 is a very appealing PE ratio. However, a forward PE is based on future expectations for earnings. If Apple can't reach those expectations, the forward PE of 12 won't actually be accurate. And since Apple expectations are so high, it will likely not meet them. Forward PE is therefore not a good barometer. Trailing PE is more accurate in this sense, and Apple's would be at around 16-17 - still fairly attractive, but not nearly as attractive as 12. Moreover, if Apple can't even keep up the earnings of the past, its trailing PE is a bad measure as well. If Apple can't meet or keep up with expectations, its PE could soon be in the 20s.
- Investors will lose faith and sell the stock as it underperforms. Apple has soared over the past few years largely because it continues to perform well and because it continues to be a crowd favorite. But if the stock starts falling hard or underperforming the market, many investors will begin to look elsewhere for good investment ideas. As investors give up on Apple as their favorite play, or ditch it because it loses them money, the stock will take a big hit as selling pressure mounts.
- Poor use of cash. Apple has had over $100 billion in cash. In fact, it's been sitting on a huge pile of cash for a while and only recently announced that it would pay a dividend and buy back shares. However, the dividend and $10 billion share repurchase program are fairly negligible compared to the $100 billion cash total. Apple may be wasting its massive hoard of cash by letting it sit, instead of increasing value for the company through acquisitions, more expansion plans, or other value-added initiatives. And the buyback could be initiated at exactly the worst time - right at the peak.
- Rising input costs. As prices rise for the suppliers, the parts required for Apple's products see their prices rise as well. With flash memory prices up and a number of other parts potentially on the rise as well, together with wages likely going up from here, Apple's profit margins could take a significant hit.
- Will have to lower prices. In order to compete with the much cheaper competition and to attract a larger user base that can afford its products, Apple will have to lower prices for the iPhone and iPad. This could tremendously hurt Apple stock because it will cut into Apple's profit margins. Even more dangerous, since most investors and analysts have not factored-in lower selling prices into their projections, Apple stock could plummet as investors scramble to revise their forecasts to meet the new circumstances.
- Phone carriers will cut subsidies. Apple has been so dominant with the iPhone, that the top phone companies like AT&T (NYSE:T), Verizon (NYSE:VZ), and Sprint (NYSE:S) have been fighting over the exclusive rights to sell it. Apple has had so much leverage over these once-all-powerful companies that it even found a way to have them "subsidize" part of the phone's price for customers. In other words, the phone companies have been paying part of the price per iPhone, further increasing Apple's profits at their own expense. And that is likely about to change: Apple can't have so much leverage with growing competition and very unappealing profit margins for the phone companies that subsidize the iPhone. The phone companies may soon cut or reduce subsidies, which will cut into Apple's revenues or profit margins.
- Patent battles. With the ever-growing importance of intellectual property and proprietary technology, there has been a corresponding growth in patent battles, patent purchases, and court cases. Big companies are seeing a lot of value in smaller companies' patent portfolios, and in some cases buy them. However, sometimes the big technology titans fight each other to defend their territory and prevent the other companies from infringing on their patents or technology. We've already seen Facebook (NASDAQ:FB) and Instagram, Oracle (NASDAQ:ORCL) vs. Google , and many more. Apple will not only be infringed on, but will likely infringe on others. More debate over patents and technology will lead to big legal fees, loss of power or leverage, and a potentially damaging court decision for Apple.Click to enlargeSource
- Anti-trust problems. During good times, monopoly-like companies are allowed their power even if competition is at a major disadvantage. On the other hand, during bad times, anti-trust activity picks up and the government and regulators scrutinize dominant companies and can even over-punish them. Case in point - the attack on Microsoft as a monopoly at the peak of the technology bubble in 2000 was both a sign that negative social mood was picking up and that strict regulation and "fair play" were being enforced. During good times, Microsoft and other dominant companies are left alone; but when bad times emerge, the negative social mood makes people and governments much more vigilant in correcting what was overdone during the bull market. We are currently approaching this phenomenon: the passing of market tops coincide with anti-monopoly activity and punishment of the strongest companies. Just as Microsoft was the target of regulation and trust-busting as social mood turned negative in 2000, so too will some of the largest companies today be targets of regulation and scrutiny as the negative social mood takes firm hold. If that is the case, we can expect companies like Apple , Google , Amazon , and Facebook to be the focus of much outrage over the next months or years as the excesses of the bull market are cleaned up.
- Poor working conditions in factories. Auditors examining working conditions at Apple's factories in China have found a number of very serious violations, from excruciatingly long working hours to big safety hazards. The increased public scrutiny and growing discontent following this Foxconn incident will likely be detrimental to Apple, as wages increase, costs rise, and resentment grows.
- IPO frenzy and technology bubble 2.0? Apple has definitely been a beneficiary of the massive hype surrounding the recent technology IPOs like Facebook , Groupon (NASDAQ:GRPN), LinkedIn (NYSE:LNKD), Zynga (NASDAQ:ZNGA), and others. However, the overspeculation currently in the market due to these IPOs will likely lead to a general market selloff. Since Apple will respond to the overall market, or even lead it, the unwarranted euphoria over the IPOs will hurt Apple stock as well. (See: Is IPO Mania Warning of a Tech Bubble 2.0?)
- Global economic slowdown. Apple has carried the markets higher and has benefitted from the economic "recovery" since the 2009 bottom. However, as economies slow down and potentially enter renewed recessions (See: 2012: On The Verge Of A Global Recession?), Apple could see a major slowdown of its own. If the economy is weak, the consumer is weak; and if the consumer is weak, he or she can't afford Apple products. As a recession or slowdown takes its toll on markets, Apple will undoubtedly be negatively affected. If it can't continue to perform based on its current trajectory, Apple could fall hard.
- Failure to catch on in China. Most Apple investors expect tremendous growth in China that will justify their high expectations, but Apple may see some major hurdles as it attempts to conquer the region. Not only are iPhone prices perhaps too high for the Chinese consumer, but it appears that Apple is already struggling in China with the iPhone having only a 7.5% share compared with Samsung's 24.3%. If Apple can't perform in China, the stock will definitely drop to better match expectations.
- Apple virus. Perhaps the scariest and most unexpected catalyst for Apple's fall will be the growth and spreading of a never-before-seen virus in Apple computers. Apple has always been touted as the "virus-free" computer - one that is safe, unlike PCs. However, it has been recently found that a Mac virus is on the rise. If a virus is able to catch hold and spread, many customers will reconsider future purchases. Is it really worth paying three times the price for a Mac (as compared to most PCs) when it too is prone to viruses?
- Slowing momentum and weak technicals. Apple has not only seen a parabolic and unsustainable rise in its stock price, but momentum has been slowing and failing to match the rising price. Not only is the relative strength (RSI) diverging, but with the 200-day moving average near $430, the stock is very far away from the longer-term average. Since stock prices tend to revert to the mean, Apple's stock price is likely to drop closer to the 200-day moving average. And with the moving average nearly $200 away, Apple is setting up for a sharp correction.
- Big insider selling. Generally a precursor to falling stock prices, when prominent insiders sell their stock in the company, it shows that they have little faith in further upside. With many Apple insiders selling their shares over the past 6 months, including over $100 million by CEO Tim Cook, the top may be in. If the top executives and insiders, who have the best information about the company, don't believe that the stock has much further upside, the average investor shouldn't either.
As we have seen, Apple is approaching a multitude of hurdles that threaten to derail it from its path of tremendous success and market dominance. From parabolic and unsustainable price rises, a massive and unappealing market cap, extreme expectations, and priced-in fundamentals, to terrifyingly ominous signs of an impending fall due to competition, slowing momentum, patent battles, and stagnant innovation - Apple is facing enormous risks that could eventually result in its losing its number one spot. Apple may no longer be #1, and investors are yet to consider or accept it. Once they begin to acknowledge the possibility, however, the stock will almost certainly drop.
Disclosure: Chart Prophet Capital may short AAPL through long put positions or selling call options.