Even With Apple, Price Will Follow Value

Once upon a time, I said Apple (AAPL) was reasonably worth $131. Despite what a lot of people said in comments here and on Seeking Alpha about how AAPL would never be that cheap again, the stock closed $1 below my target this week.

Gloating is unprofessional, and although I might find some shallow satisfaction from hammering home AAPL’s current price point to the people who said rather unpleasant things about me when I came out and said Apple closing in on $200 is crazy speculation, I’m not going to do that.

But revisiting what happened with Apple is worthwhile, because I think there are two important lessons to be learned:

1. Sector rotations can do funny things to stocks.
2. Valuation matters, even to growth stocks.

In 2007, pretty much everyone was stunned by the performance of the high-multiple tech darlings of Google (GOOG), Research in Motion (RIMM), Amazon (AMZN), and Apple. And as much as I regret to say it, what was happening was very obvious: plenty of institutions saw the economy was slowing, and they all piled into the fast-growing tech names. It’s simply the sector rotation that makes sense at that time, given the macroeconomic conditions at work.

Consider the performance of those four stocks in 2007:

click to enlarge

One thing I was criticized for, repeatedly, following my AAPL valuation, was that I didn’t appreciate how wonderful the products are and how fast the company would grow. What too many people don’t understand is that the particular driver of growth sometimes doesn’t matter as much as the secular picture. The same people who were buying AAPL to $200 were buying RIMM to $140, and all the analysts believed in the great stories those companies had with their handsets – even though the objective valuation said they can’t both win, given the implied expectations. What mattered more was that these were fast-growing, technology-based companies in a slowing macro environment. Another fast-growing, technology-based company had one of the most boring products in the world, yet did great nonetheless. AMZN caught fire because of the broader growth story there, not because selling books was suddenly sexy.

How does this relate to Apple? I’m not going to dispute that the company is innovative and gets plenty of people excited about its products – but this is where investors got carried away. The same analysts who were playing poker with their price targets (“raise to $225,” – “call to $250”) couldn’t care less about the feel-good side of the products, they just wanted to make money. And for a very long time it was profitable to be on the long side of the AAPL trade - because of the sector rotation going on. Yet nothing I read about Apple ever mentioned the fact that the stock was positioned to outperform just because of the sector. Everything always revolved around Macbook growth and iPhones and touch screens. People got deluded into believing good times would last forever, and Apple would always be a more attractive investment option than anything else. The side effect of this is that people confused the quality of the products Apple makes, with the quality of the stock in their investment decision process. Or, more simply, they ignored valuation.

“Fair values mean nothing to growth stocks.”

Or so one reader said, and he is certainly entitled to feel that way if he likes. But I tend to agree with Joe Ponzio and others who say that price always catches up to fair value. Now, do I know if my $131 valuation target from October is really right-on considering AAPL closed less than a dollar away from that to end the week? No. It’s a valuation, not an immutable number. That said, I believe it is much closer to what rational investors should pay for a share of AAPL than, say, $250 – even if Gene Munster thinks so and Fake Gene will probably make fun of me for saying this.

Chart of AAPL vs. Nasdaq, since October 13th, 2007:

So what now? At present, I have no strong feelings on AAPL. A large portion of what I see as excessive speculation has been unwound, yes, but that doesn’t mean I would buy this stock – far from it. I’m going to make a huge leap and compare Apple to Berkshire Hathaway (BRK.A) (BRK.B). With Berkshire, you can unequivocally trust management and your fellow shareholders as being partners in the business. There won’t be wild day trading in either BRK, and management focuses on building the business rather than appeasing analysts. With Apple, a large contingent of shareholders believe the company is only as good as the performance of the stock in the last quarter, and management’s consistent habit of playing guidance games has finally served to burn shareholders. Of course, the guidance games were never a problem when the stock was going up – as Todd Sullivan notes – so I have to disagree with Trader Mark that everything is alright. Things have changed (remember that part on sector rotation), and now the game is being played a different way. So why take part in the evolving Apple earnings drama, when there are plenty of other good businesses on the cheap that should benefit from sector rotation, like US Bancorp (USB), American Express (AXP), and Bed Bath & Beyond (BBBY)?

Comments

[Jon T:]

Everything that was true about Apple when it was $200 is true today.

Apple has been subjected to a massive bear attack and it will bounce back as its strategy shows that the fears to its performance from a spending slowdown have been totally overdone.

At $130 you buy into a ridiculous certainty, it's like being allowed to see into the future by going back in time 12 months!

2008 Jan 28 07:00 AM

[Tom B:]

"So why take part in the evolving Apple earnings drama, when there are plenty of other good businesses on the cheap that should benefit from sector rotation"

Umm-- because the other stocks you mention aren't growth companies due to dominate several new markets?

BTW: I wouldn't touch AMZN-- THERE'S an overvalued pile of nonsense! High P/E; low profit margin; "one-trick pony".

2008 Jan 28 07:05 AM

[dynein:]

If AAPL had corrected by itself back to 130, then you get credit for insight. It doesn't count when the whole market sells off and you claim credit for your "insight" into the reasoning for one stocks drop.

2008 Jan 28 07:21 AM

[digivision:]

I certainly see your point and you are probably right here and there
however Apple is not a $130 stock the company is worth a lot more
even if the iphone should "flop" Apple's revenues and growth , retail stores performance etc.. is top notch and hardly any company can match their performance... said so yes like normally happens people gets carried away but this is simply a temporary correction, the stock will soon return in the $150-$160 range(when they announce the SDK) and it willclimb even more after the next big announcement like the 3g iPhones and new distributing deals

2008 Jan 28 09:03 AM

[Tom B:]

The thing ALL the analysts seem to forget is that AAPL's domestic computer market share is 6-8%, depending on whose numbers. That leaves the option of >10 fold growth. Yea-- I know-- not gonna happen this decade. But we could easily see market share double this decade, particularly when Enterprise starts to figure out it ain't 1981 anymore; antiquated DOS-spawned operating systems look longer in the tooth every day, between the security and the performance issues.

Obviously, MSFT had a big quarter, but who's to say some of their Vista sales weren't Mac users dual-booting with Boot Camp to run legacy Windows apps.

2008 Jan 28 09:22 AM

[top_tier:]

"Gloating is unprofessional, and although I might find some shallow satisfaction from hammering home AAPL’s current price point to the people who said rather unpleasant things about me when I came out and said Apple closing in on $200 is crazy speculation, I’m not going to do that."

You just did. "Gloat". lol

2008 Jan 28 09:28 AM

[Uncle Miltie:]

"management’s consistent habit of playing guidance games has finally served to burn shareholders. Of course, the guidance games were never a problem when the stock was going up – as Todd Sullivan notes – so I have to disagree with Trader Mark that everything is alright."

Two problems with this argument:

1) Todd Sullivan is an idiot and has as much credibility on AAPL as the gum stuck on the bottom of my shoe.

2) Apple does not "play games with guidance". They provide very conservative guidance that they will meet, and do not give updates at any other time than during quarterly reports. The only games are the ones being played by analysts who speculate what the actual earnings will be.

(FYI, current guidance is for FY-Q2 for Apple - it's slower than Q1 every year, and somehow analysts are always suprised that Apple's sales are lower in the quarter after Christmas every year, but YoY sales are up significantly...)

2008 Jan 28 09:42 AM

[sfhc21:]

James, let me remind you of what you said from an earlier article, titled "Over-Hyped Apple Has No Real Value".

"So I'll fit the growth curve to that, which means taking into account analyst estimates for 34% growth in the current quarter (I'll put that as my full year-one growth even though growth estimates for the next quarter are 18.5%)"

Try 54%. The problem with your model is that you are always significantly below what Apple's true growth will be. I can give credit to those who deserve it. But your numbers are so far off that you simply don't deserve the credit. It simply proves that you don't understand the growth Apple is experiencing and that, like you said, Apple was a victim of sector rotation and the general pull-down of the market.

2008 Jan 28 09:42 AM

[ThinkFirst:]

Price WILL follow Value. About that you are right. But, you have the direction wrong. With $21 per share in cash, no debt, and significant growth ahead in personal computers and smartphones worldwide, the current price of 130 will look like a "missed opportunity" a year to 2 years from now.

2008 Jan 28 11:46 AM

[James Cullen:]

Uncle Miltie: "Apple does not "play games with guidance". They provide very conservative guidance that they will meet, and do not give updates at any other time than during quarterly reports. The only games are the ones being played by analysts who speculate what the actual earnings will be."

Exactly my point. I don't want to extrapolate things too far, but how is guidance that is all but assured to be beat helpful in any way?
Along those lines, the question with many of the financials is whether or not they are taking "kitchen sink" writedowns in order to look better in the future... is that really any different from what Apple is doing?

Also, it's important to note that (as you said) the analysts are speculating on earnings, and thus speculating on price targets, because this is a speculative stock. Recognize it for what it is.

2008 Jan 28 12:12 PM

[Richard Alv...:]

James,

So you believe there is $100 dollars worth of speculation? Not sure how multi billion dollar loss has anything to do with the way Apple reports their guidance.

2008 Jan 28 01:48 PM