Over the past few years, Apple (AAPL) has grown dramatically in market share and market price. In the past 10 years, the price per share of Apple has increased by over 2,300% and by many accounts this growth is projected to continue. Through this report, I will make the argument that further strong growth of Apple is not fundamentally warranted and that Apple is beginning to become a marginal business.
Within the past month, many investors eagerly anticipated and were subsequently disappointed by Apple's financial statements. One of the primary numbers that many individuals have been watching is net income.
The chart above puts the quarterly net income in perspective over the past 10 years of data. As most know, net income is simply income of the firm minus expenses. This is one of the most widely-watched metrics of company performance and many individuals have been proclaiming the exponential growth of Apple's earnings. The chart above clearly shows this exponential growth, however within the past year, earnings have experienced an incredibly sharp correction. Despite the pundits proclaiming the strength of apple, it is very interesting to note that within the past two quarters, Apple has decreased their earnings by more than their entire earnings of 2011. Additionally, this decrease in earnings is more than their entire earnings over the 8 years between 2002 and 2010. This powerful correction shows that Apple is experiencing a shock at the very core of their business.
Despite a decrease in net income, there are other factors at work which have been warning about a decrease in market power of Apple for several years. One of these factors is a simple ratio known as the current ratio.
The current ratio is current assets divided by current liabilities. This simple ratio is one of the most basic forms of fundamental analysis and it carries powerful implications as to the strength of a firm. The current ratio measures the relationship between what a firm owns and what at firm owes. Essentially, if the ratio is above 1, the firm is able to satisfy its current obligations with the assets it currently has at hand. For the years of 2002 through 2009, this ratio was fairly stable and indicated that the firm was more than able to satisfy its liabilities. In 2010 however, Apple took a significant turn for the worst. During the years of 2010 through the current year of 2012, Apple has steadily outpaced its assets with its liabilities. This decrease in the current ratio warrants added significance in that during these same years the exponential growth in net income began in earnest. This strong relationship tells the alert analyst that Apple's growth was fueled by added risks which have endangered the firm. As Apple made thousands of headlines due to its strong earnings, it was sacrificing the ability to satisfy its obligations. This is a tactical blunder which strongly points to a decrease in the ability of Apple to sustain their current trend in market growth.
Another important method of examining Apple is to critically analyze how efficient they are performing. If an analyst believes that a firm is becoming less efficient, then he or she should be able to validate this claim with hard data.
The above chart shows the asset utilization ratio. This ratio is the total revenue of the firm divided by the total value of assets that the firm owns. The reasoning behind this ratio is intuitive in that it indicates how efficiently a firm is using its assets to generate revenues. As the ratio increases or decreases, efficiency is increasing or decreasing. In the above chart there are several intriguing elements to be noted. The first issue at hand is the decline and subsequent stabilization of the asset utilization ratio. During the 4th quarter of 2005, Apple was the most efficient it had been within the past 10 years and since then, efficiency has been declining. Despite this obvious relationship, a less seen relationship exists. Since 2010, Apple has experienced a decrease in efficiency. These years coincide perfectly with the beginning of the exponential growth of net income and rapid decrease in the current ratio. Essentially, this means that Apple has sacrificed efficiency to gain market performance which has driven a decrease in the ability of the firm to satisfy their liabilities. What this boils down to is that the previous two years of market performance have been driven by an unsustainable business model!
Since Apple began its aggressive growth in 2010, it has operated under a fundamentally unstable business model. If it continues at the rate it has been growing, Apple will soon be unable to satisfy their liabilities (as measured by the current ratio) and they will sacrifice efficiency to the point that they are no longer able to outperform their competitors. It is very important to note that this does not represent a reason to sell or short the stock. In order to sell or short a stock, we must have a fundamental reason of underperformance. Despite my strongly negative stance on Apple, I do not feel that any of the above indicates a decrease in stock price. What the above research indicates is that Apple is becoming a marginal business. Essentially this means that competitors will win to the point that Apple is operating just at their cost of doing business. In simple terms: the bubble is over. Apple is now becoming a standard company and it has reached the apex of its growth rate.
The ramifications of a marginal Apple are very significant in that it now means that the investment should be treated as a standard stock investment in a normal business which has already reached its apex. I have found that by thinking fundamentally and executing technically, I am able to efficiently enter and exit investments. This said, I have completed an exhaustive technical research of Apple in order to determine what is the best way of entering and exiting the stock. The chart below shows the percent gain achieved by using a certain moving average period to act as entry and exit signals in Apple stock.
It is important when doing this type of research to note areas of consistent results. The reasoning behind this is that history does not predict the future perfectly but it gives us insight into how events could transpire. This said, we want to try and position ourselves so that we can best capitalize on the repetitive nature of history. The chart shows market performance gained by using a single moving average as our entry or exit signal. As seen in the chart, this performance varies wildly but a region of stability is in the 160 to 260 range. In order to position ourselves to best exploit history, we should treat a moving average within this range as our investing signal. It is very interesting to note that the moving average period in the middle of stable historic performance is 200 - a widely-watched indicator within the markets.
In order to best capitalize on the marginalization of Apple, I believe that investors should wait until price trades out of the current 6 month trading channel or breaks below the 200 period moving average to sell or initiate short positions. A break above $620 will be a signal that the timing of the analysis is not right; however, fundamentally, the marginalization of Apple is an eventuality.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.