Is Apple A Buy Here? Valuation By Intelligent-Behavior Analysis

Sep. 4.12 | About: Apple Inc. (AAPL)

Over the past several years Apple Inc. (NASDAQ:AAPL) has earned its way to the top of the equity-capital-invested mountain. Of the some $12 trillion so invested, its $623 billion, while only ½ of 1%, is the focus of investors worldwide.

Much of all equity values are a matter of perception. So much, it almost always staggers reporters, regulators, and politicians as to how great quantities of capital value can be created or, more often, vanished, in so short a time.

Put to the crunch, the market activity on AAPL shows 14 million shares traded on a typical day. At today's price of $665, that is a $9.4 billion activity. Such enormous market liquidity means that AAPL's entire capitalization gets turned over in a mere 66 market days. Three days more than one calendar quarter.

But a further examination shows that the incremental capital moving its price is far less. All the rest is just capital changing hands.

We looked at the last 8 years of AAPL market activity to see what it took to move the stock's price from $30 a share to 22 times that much.

The math is easy. Each day's share volume times the closing price is the total capital traded. But if the price increased over the prior day's price, it is only the price increase percentage of the day's total capital traded that adhered to the perception of value by the market's participants.

On any day where the price declined, then a similar proportional part of the day's trade was extracted from the perceived value.

Tracking those cumulative changes Since August of 2004 takes us through periods of market elation and trauma, dramatically revealing how investors handled their capital invested in AAPL during the period.

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What it shows is that in the three years up to November 2007 an incremental almost $10 billion took the stock up from $30 to over $180 a share with few interruptions.

Then in two short months, from the end of December, 2007 to the beginning of March, 2008, $6 billion of incremental capital was withdrawn, taking that total from $9.6 billion to $3.6 billion. That's a loss of 5/8ths or over -60%.

What happened to the stock price? It went from $200 to $120, only a -40% drop. Bargain buyers propped up the value perception with their replacement capital in the trades initiated by those fleeing the scene.

The picture shows a capital inflow in the second and third quarters of 2008 until the market panic took over in the fourth quarter. This one took the incremental capital down below $2 billion, from where it has been building since.

It is the accelerated incremental capital inflow since the beginning of 2012 that has experienced investors concerned. That push alone has injected a new $5 billion of perceived value, raising the flow from $6 billion to $11 billion+.

AAPL is now in its own world, half again larger in market cap than its closest competitor. Is it sustainable? Or might some Japanese judge's ruling (or something else) panic enough of those on this luxury cruise liner over to the other side of the boat?

Lots of earnest, well intentioned observers have an opinion. Lots of others are quick to offer advice, perhaps driven by, as Niccolo Machiavelli commented circa 1600, "everyone has his reasons."

With investments, the best advice often is to "follow the money." It is, after all, big money pressure that moves prices. What the big players think and are likely to do, matters.

But they are careful not to reveal their intentions, in the realistic fear of being front-run. Still, even with as liquid a stock as AAPL, their changing needs often call for market assistance from firms that keep teams of their most skilled and experienced folk concentrated on this stock alone. The fund-management-client portfolio managers have many other stocks to consider and deal with in the course of an ordinary day.

So, we look to those market-making pros to tell us which way the big-money wind is blowing, and if that wind is shifting.

Now, they are even more cautious of the front-run than their clients. It takes one to know one. Plus, they are masters at hedging any risk they are required to take, in order to fill a client's million-dollar order. Which orders occur by the thousands a day.

It is the risk hedging that tells us the extent of the market-makers' price concerns, both to the upside and the downside. The hedging is firm capital being spent to protect it from loss. What they are willing to spend and how they spend it tells what they think their big fund clients are likely to do. Or not do.

We have been reading for several years the footprints they leave in the hedging markets. On stocks like AAPL the message is usually quite clear. The following picture shows what they have been forecasting as prospective price ranges each day for the past 6 months. This is not a high-low-close chart; it is a history of forecasts, shown by the vertical bars, with the day's-end quote at the heavy dot.

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What is significant here is the balance between upside and downside in each day's forecast. We measure that by a Range Index, which tells where the current price is in the forecast range, where the low end of the range = 0 and its high =100.

Over time each stock develops an array of Range Indexes specific to the way it has been viewed by investors and the market-makers. Here is how they have seen AAPL daily since mid-2006:

Click to enlargeThis is not some formula-derived distribution. The Range Indexes for AAPL run from 5 to 75, with a median of 35. Look carefully around 65. As equidistant from the median as 5, this tail is fatter, more extended.

What is important is how AAPL's prices behave subsequent to the forecasts. This next picture shows the proportion of days in the 3 months following each forecast that are either higher (green line) or lower (red) than the day of the forecast.

Click to enlargeAnd this picture shows by how much they are either higher or lower. Please note the white zero level.

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While the sizes of gain opportunities are attractive across most of the array, the size of potential drawdowns gets progressively more severe as the Range Index increases.

Combining the Odds and the Payoffs provides the following weighted- net-result picture:

Click to enlargeWith AAPL's Range Indexes in the 15 or less area currently, a history that covers a wide spectrum of market conditions urges continued enthusiasm for the stock. There is no sign at present that big-money players are losing their appetite for AAPL.

Of particular encouragement is the continuing upward trend of forecast ranges shown in the second picture of this article. When serious investors start getting shy on this stock it will show up in static or declining forecast ranges. Also likely, current price dots may rise in the forecast bars to indicate Range Indexes rising above 35 or 50.

But there's no sign of that yet. The current forecast is for a sell target of $777, and a drawdown exposure to only $658. The upside is +16.8% and the downside is -1.1%. Maybe hard to believe, but historic odds and the big-guns' informed perceptions are still on the long side.

While the potential gains pictured above may appear small, please keep in mind that they cover periods of only 3 months, and can be compounded some 4 times a year. A gain of 5% augmented this way turns into a +22% return. In a subsequent article we will discuss how the actual AAPL experiences have averaged significantly more than that.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.