Apple: Great Company with Lofty Valuation - Due for Pullback 71 comments
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Apple (AAPL) seems to do no wrong. The shares have vaulted nearly 50% since their March lows and the 3G iPhone is the current rage. The hype is at unprecedented levels, resulting in an analyst love-fest that is in full swing. Is another classic case of 'pump and dump' developing?
The case for the iPhone: There is ample opportunity for AAPL to penetrate and make further inroads within the corporate market segment, and in the process, take substantial market share from Research In Motion (RIMM). In fact, HSBC Bank is contemplating switching from RIMM's blackberry to AAPL's iPhone. This change alone could amount to a 200,000 unit order, however much of these potential orders could already be factored into the current share price.
Valuation is rich: Could AAPL start to sour? Everybody and his brother is tuned into the fact that AAPL management typically under promises on its guidance in order to over deliver. 
Most savvy investors can see right through this quarterly façade and likely incorporate a 10-20% "beat" modeled into the actual earnings results. The company is very reliable at beating estimates, however, and often the share price dives just after the release, as the phenomenon of "buy the rumor, sell the news" rears its ugly head. The analysts certainly appear to pander to management's guidance and sandbag their estimates to coincide. The consensus of 2008 earnings expectations of $5.21 and 2009 estimates of $6.06 (YOY growth rate of only 16%) compute to forward PEs of 34 and 29 which are on the high side compared with Google's (GOOG) forward PEs of 21 and 26. If you decide to "play the game" and pad the earnings estimates an additional 10% to offset the lowball guidance, you still end up with steep forward multiples of 26 and 31.
Insiders are heavy sellers: AAPL insiders have been on a recent selling spree. In just the last 6 months insiders have sold nearly $175 million worth of shares. Why are they selling? Do they know something the rest of us do not? Anthony Fadell, a Vice President, recently sold 71,500 shares on 8/11 at $172.49, after exercising an option to purchase 71,500 shares at $14.03 per share—this single payday of $12 million makes superstar athletes compensation look pale in comparison. The exercise of options creates three negatives (1) More shares are added to the supply (2) the added shares cause earnings dilution. (3) the company incurs payroll taxes on the gain that the employee realizes.
iPod and Mac: The success of the iPod is fleeting, as its market has been saturated. Its status is now similar to a star NFL running back entering his tenth season. The poor overall economy is bound to eventually slow Mac's desktop and laptop momentum, and the company could be forced into a price cutting mode to combat soft demand.
Wild cards: Will Steve Jobs be able to maintain his health? Will AAPL be successful in a timely manner in eliminating the glitches surfacing with the debut of the 3G iPhone? How much will the recent strength in the US dollar hurt AAPL's international sales when those foreign currencies are exchanged back into US dollars?
Bottom line: Don't get me wrong, I certainly think AAPL is a great company, I just don't like it at the current share price, as it has simply gotten too expensive by rising too far in too short of a time frame. I also think that some "weakening" of the fundamentals could begin to creep into the equation. The shares are overbought and due for a correction. The risk simply outweighs the reward at this juncture and a 10-20% drop is plausible.
Disclosure: Short AAPL
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This article has 71 comments:
Anyway, other than that, I appreciate you points.
good luck on your short, lets hope you have a tight stop
This statement, based on your personal opinion, has not been backed up by fact. The economy has been constrained all year and Mac sales increases have been triple the overall market PC market
Anyone can have an opinion, but when it is not back up by real world observation, you just look stupid and uninformed.
Payroll taxes? Get in the ball game. What about the huge tax deduction that the company gets with no cash outlay! The in-the-money element is a tax deduction to the company (and compensation to the employee).
I think that you're grasping at straws to put an unnecessary spin on AAPL. By the way, if AAPL can dent RIMM (and I think that they can jackhammer them within 3 years), what will this do to their earnings?
Also, unless you have a very short time horizon. I would not bet against Apple exceeding its previous high within the next year. That still a significant gain form this level.
"recent strength of dollar" will hurt Apple's exports? give me a break! look at a 2 or 5 year chart of dollar vs Euro.
And I always love "Inside Seller" theories! "What do they know that we don't???" well, lots I'm sure, but if they start buying or selling based on inside information, their entire gain will be eaten up by legal fees and fines, and they will be having tea with Martha!
Hey! Look back at Ron Johnson (Officer), and his direct sale of 470,000 shares in Feb 07 ! He sold at $86 for a cool $40 million !
What did HE know??? I'm not sure, dut I guess he DIDN'T know that AAPL was going to touch $200 last Christmas!
So much for reading into Insider Trading.
Here's one... if you see value breaking technology development and inspired application, Apple is only at the tip of their iceberg. They are incredibly forward thinking and continually create unique, trend setting items that people feel they MUST have.
Since Apple released the iPod, I've been in the stock and have always made way above market. So, until their innovation and product release cycle slows or stops, I'm in like glue.
Thanks for listening.
Veronica
It's erroneous. Look at the cash generation machine working flat out with subscription accounting for iPhone, iPod Touch, Apple TV and Applecare
If someone exercises options, aren't they now dealing with stock sales, subject to Cap Gains tax, and that's it?
I guess if AAPL shares STAYED at $14, so the options were worthless, we would all be toasting to the tax payments we saved, right?
I guess every silver lining has a black cloud if you just take the time to look for it!
Also, the "3 reasons" insider sales are bad really seem like TWO reasons, as the first two are sort of redundant:
- It increases the amount of shares out there
-It dilutes the earnings per share
Do I really care how many shares are out there, except that the earnings are diluted over that number? kind of redundant, and grasping, as the author realized that "two reasons insider options are bad" just didn't have the "zing" that THREE reasons did!
So he padded the reasons.
weak.
People have to exercise options if they are about to expire. Personal income taxes have to be paid on the gain, and where will the cash come from to pay these taxes??
seekingalpha.com/artic...
Short Apple in Fall? Last year it was up practically every day, it was unbelieveable. I think this fall will be bigger, because the iPhone sales are off the hook, and Mac sales will be much higher than ever because they included iPod touch or nano with every back to school laptop or iMac. I am on a campus in the midwest. We used to rarely see Apples, now most of them are Macs. This has all happened in the past two years, and again, last year was a phenomenal fall for Apple.
Good luck with your short, lots of people, no doubt, would love to get in cheap though, so I wouldn't wait too long to buy if I were you.
This is like saying "everything is reflected in the price" one year after the introduction of iPod - imagine how much was lost by "investors" that listened to exactly the same points then. There is every reason to believe that iPhone will be much bigger for Apple then iPod could ever be.
Have to give the credit to the author for stating his short position. Most of the same negative spin is recycled by the media as unbiased opinion. Perhaps that is what the author refers to as "hype", since there is some negative article somewhere about Apple and it's products practically every day.
Incredibly shortsighted, intentionally so.
And again, Apple's vertically integrated platform has no competition because Apple owns all the parts, from hardware to the App Store.
I say hold Apple for the long term; pullbacks are just buying opportunities for this company. Just my opinion.
will execs with lots of shares cash in from time to time to get lots of $...yes. will apple shares lower from time to time?...yes. are there people who want to push the price down so they can grab shares cheaper? yes.
it won't matter. Apple is here to stay, even if, eventually, without Jobs.
not even CEOs live forever. But today's apple is different from the past. it's huge with an enormous company of talent, innovation and vison... and, it's got a lot of cash reserves, multiple profit streams, no debt...and...more amazing products in the pipeline.
it's really not comparable to google, dell or anyone else. apple has the most profitable retail space in the country. i don't see anyone else being even close. i suggest that before writing about apple, stop into one of the apple stores...play with the toys...maybe you'll start to understand this company which is unlike any other.
Reuters numbers
Trailing P/E: GOOG - 32.86, AAPL - 35.06 (Reuters)
Trailing P/FCF: GOOG - 38.34, AAPL - 26.53 (Reuters)
At this point, a knowledgeable researcher would wonder why Apple's free cash flow was so high relative to Google's, since its earnings were slightly lower. Digging into the details, one would learn that Apple defers 7/8 of new iPhone revenue every quarter. What that means, dear reader, is that Apple's future earnings will be augmented by money that's already in the bank. So in this case, P/E doesn't provide a good view of Apple's profitability, and is a poor means of comparison.
Unfortunately, I don't think we get FCF forecasts (Andy Zaky would know, however), so future valuation comparisons based on it are difficult. You could use expected earnings growth, but I think that the consensus on AAPL's 2010 earnings are low, based on low iPhone estimates. Note that AAPL is expected to grow earnings faster than Google in 2009.
"AAPL insiders have been on a recent selling spree. In just the last 6 months insiders have sold nearly $175 million worth of shares. Why are [insiders] selling? Do they know something the rest of us do not?"
Do you have any idea of the value of shares and options held by insiders? I don't, but I'm guessing it's in the billions. And if my wealth were concentrated to such a degree, you're damned straight I'd be selling to diversify. Add to that the significant chances that a Democrat in the White House would increase capital gains taxes, and you've got a huge incentive to sell now.
"the iPod...market has been saturated."
Could be - but I think we've been hearing this for years. I expect further innovation from Apple in this area, as the Touch concepts work their way through the lineup. And don't forget, one of the primary drivers of this market are teenagers, and there's a new batch of them every year.
"The poor overall economy is bound to eventually slow Mac's desktop and laptop momentum, and the company could be forced into a price cutting mode to combat soft demand."
Looks to me like the company's already anticipating this (see earnings call transcript), and may be on the verge of a significant push to grow market share through less expensive models. Decreased margins? Sure. What's the most successful retailer in the history of the planet? Did it get that way through higher margins or higher revenues?
"The risk simply outweighs the reward at this juncture and a 10-20% drop is plausible."
Enjoy the ride.
Disclosure: Long AAPL
I can't even believe you wrote this knowing that Apple would beat those numbers, Apple is gaining market share, and Google is stagnant in terms of market share. You obviously don't remember why Google got hammered after they reported last quarter.
Google is not as a good a stock as Apple.
-They aren't going to grow the market share in their core business like Apple will with the Mac.
-Apple has proven income streams from multiple businesses.
-Google's estimates are predicated upon growth in overall advertising and a continued shift away from 'traditional' advertising.
"The exercise of options creates three negatives (1) More shares are added to the supply (2) the added shares cause earnings dilution. (3) the company incurs payroll taxes on the gain that the employee realizes."
1. More shares added to the supply is not, in and of itself, a negative; it increases the liquidity of shares, so technically it's a positive.
2. Earnings dilution - absolutely right. And the dilution caused by a million new shares? A whopping 0.113%. That's right, instead of EPS of $5.21 this year, you can only expect $5.204.
3. Payroll taxes. Since Social Security tops out at around $100K, I'm going to assume that the payroll taxes you write of is just Medicare. At 2.9%, that comes to about $5M for the two quarters you reference. This caused a reduction in FCF of less than 0.25%. So instead of $2.35 in EPS over that period, AAPL might have hit $2.356!
You're right, those options, which keep key employees around, are just too expensive.
I thought it was okay at $175, but now that I've learned it could be as high as $175.42 if not for those pesky options, I'm not so sure anymore...
The kind of frothy hysteria I am parodying here makes me sure AAPL is due for a pullback. Certainly its a good company and inspires fanatical loyalty among its followers but nothing goes up for ever. Anedotally I think that many of the things that worked for Apple as a leading niche innovator may work against it, culturally, as a global technology hegemon that everyone here seems to believe it will become.
Of more important and timely significance is the fact that AAPL is holding its own today in a very down market and it appears that institutional buying on the rise, moving from -6.4% to -5.6%. So, if AAPL is due for a pull back its would only be because the shorts would like to see one.
The iMacs are now third in sales (after HP and Dell) moving from 3.5% to 8.5% of market share. Microsoft took 5 years to produce Vista, Apple took 11/2 years to develop Leopard. Vista is bloated, Leopard runs rings around it for speed and ease of use.
Apple has now gotten an image for quality and superior products that work very well together, like Rolex and Mercedes they attract based upon this image. People don't mind paying more for a superior product. Back to school sales and 3G iphones in other countries will make Apple's future earnings great.
-Another SA blogger wrote an almost identical blog, which seems a little suspicious.
-The writer himself, admits the estimates are low-balled, yet he bases his calculations off them.
-Google stock got destroyed after they reported because their market share was essentially flat.
-There is a good possibility that Android will be a non event and a total flop.
-Apple estimates have a major hit to the top line due to recession already factored in so those estimates are a worst-case scenario.
-Most analysts are basing their estimates on Ipod sales projections that don't factor in new additions to the product line (look at the shuffle).
-Apple's market share increase in the pc market is continuing unabated.
Wrong. See Xerox.
Further to that, repeating rubbish clichés will just prove you to be as foolish as the ones who've said them in the first place.
Like, for instance, "the success of iPod is fleeting". How can you say that when the iPod is now selling at a rate of 11 million per quarter? If the market - as you state - would be getting saturated how could this be?! If it was getting saturated Apple would be selling something like 3 to 5 million replacement iPods, given the lifetime of such devices.
Furthermore, the Apple markets can only be expected to EXPAND due to the enormous reach the company is getting WITH ZERO COSTS IN ADVERTISING, as Apple's carrier partners will be doing all the advertising AND sales of Apple products internationally for free!
And believe you me, it won't be long until carriers will be selling iPods and light notebooks such as the Air that they can promote with their 3G modems. Case in note, I am seeing the EeePC being sold by Vodafone with a 3G modem, what stops them to sell the next Apple iPhone/mini-tablet?
Apple has surely realized that, with the iPhone, they could garner a group of 100+ financially very powerful allies that do the selling and advertising for them - and that is not in the US but globally, namely in Apple starved countries like India, Brazil, Russia and China! And they went for it and did it!
How can you short a company that besides innovating in its products, with its correspondent market share expansion, also innovates in marketing strategy like the above mentioned?!
How can you short a company that is expanding - sorry, exploding globally as Apple is?!
I apologize, Mark, for having called you a fool. I was wrong. You're not a fool because you know all this that I have written. You are no fool, you know exactly what you're doing.
And that's how worthless and manipulative your texts are!
I don't expect to read any other text coming from you, Mark. That's how it is. You write rubbish expecting to make a buck on account of it. If it was a novel, at least people would be entertained! But it's not. It's just rubbish.
That says it all. That and the fact that this is merely a repeat of another SA blog. I have lost all respect for this website.
Here's my next prediction:
Apple Inc.-->Lower gross margins and shifting technology is stated; growing popularity and excellent all around OS, hardware and customer service. Predictions of revised ipods and revised laptops. Large push of current ipod touch inventory (free or cheap with Mac purchase). Apple's batteries, screens, chips, etc. are tit-for-tat no better than anyone else's; although overall hardware is generally rated more reliable.
I refer you to:
www.forbes.com/2008/05...
or
www.inhabitat.com/2008.../
IMHO, as soon as Apple had a working prototype they filed the patent; manufacturing upstart costs will be large. Here is the gravy--> ipod touch, iphone, and all laptops could run on sunlight or indoor light. The batteries would only be used for dark times; i.e., at night on a plane. Who else can run 15 to 20 hours a day or better. Add to this, any competitor who wants to compete will have to pay Apple money for the right to use the patented technology.
Can you say "iphone Solar" or "itouch solar", or how about MacAir Solar.
All I can say is Ch-Ching!!!
Correct. The first version of a GUI was indeed under development at Xerox PARC, but they weren't sure what to do with it and had decided to abandon the project. Mr. Jobs hired key members of the PARC team to develop it into a working product. I know because my best friend from high school was on that team and they turned a scrapped idea into the first Mac. My Brush With Greatness.
By your writing style, you're not an uninformed person. So what's your reason for writing such an uninformed piece?
I see a lot of these short side biased blogs on Apple that just boggles my mine. I finded it intreging to here someone write such a negative piece on a company that is accellerating cash flow by 35%+ per annum and will top out near $40Billion within a year. With such a matrix, who cares about less than 0.1% stock price dilution.
Come on, be honest for once and tell us the real reason for this useless piece.
Did you back out cash before applying P/E ratios? Did you think to make any comment on how deferred revs and earnings do not seem to have been factored into analysts' predictions?
Have you considered that Apple has done quite well in the current macroeconomic climate, contrary to naysayers like yourself? Have you paid any attention to Steve's health issues? And, even if the dollar has strengthened slightly, have you done any analysis on pricing of Apple products in foreign countries to figure out what the potential impact could be? No, none of the above? Well, without that disclosure, I think anyone would take your comments with a huge grain of salt.
Apple-mania - "This time, it's different"
As great as Apple is (just bought an IPhone 3G and love it to death), I think it can only last so long. Apple is not really a tech company - it's actually in the fashion business (neither is Google - it's an ad company). IPhones also have the potential to cannibalize IPods. Lastly, I simply cannot imagine a world where Macs dominate the PC industry - they will always run as that novelty "stylish" PC against the corporate behemoth that is MSFTINTC.
Bottom line, AAPL is the product of the genius that is Steven Jobs. Have you seen him recently?
That's old-school thinking. Younger people know that computers don't have to be ugly and clunky. And they are the CEOs of tomorrow.
But they did create the seeds from which the Star was created, which was the first commercial window based computer.
I appreciate your point of view, but see a couple of things differently.
1- Apple most certainly IS in the tech business. Their computers ARE tech, the iPods are tech, and the iPhone is tech. Did you just buy a new tie or does your iPhone make calls. It happens to be perhaps the ONLY one in the tech business that really is devoted to the total user experience.
Partly because they are the only ones who do it, many people do not understand this, and think that it is just fashion. Others appreciate that this is a completely different approach. To make function beautiful does not diminish the functionality - rather it increases it. For example: Robert Maillart made beautiful, graceful bridges. Did the fact that they are gorgeous diminish make them fashion statements and not bridges? Is there anything that a Mac cannot do that a Windows PC can? (You cannot even say run MS Windows anymore!)
So I am afraid that your "fashion business" statement misses the point.
2- "Cannot imagine ... where Mac dominates the industry"
You may be right, maybe Mac OS will never replace Windows OS. What if it only gets 40% of the business market worldwide over the next 10 years. (even 25%). That would be pretty big!
yes?
Well, DUH!
Apparently you didn't do this, which immediately casts doubt on the whole validity of your article, let alone the glaring errors in assumption that you make.
Just enjoy yourself as you keep watching the stock rise over time. You can think about all the money you either left on the table or lost outright.
Disclosure: VERY long Apple. (and darn glad to be there!)
Does anyone really think that a weakly-written blog criticism of AAPL is going to bring the stock price lower? David Einhorn struggles to talk the ALD share price lower, and he gave a well-publicized speech, wrote a book, and actually makes sense in both. If you believe that random internet chatter can make AAPL stock cheaper, you should be happy, because it will create buying opportunities for you.
JosephKr: Your argument would apply to any stock. Do you mean to suggest that buying puts is objectively better than shorting shares? Why does short-selling still exist, and why do well-known, successful investors practice it? Also, buying puts has the same upside potential as selling short - the profit limit occurs when the stock goes to $0.
To those who talk up cash: Of course a company should have some cash, but a company like AAPL really should not be sitting on this much cash. If your reason for investing in stocks is to have claim on a big pile of cash, why not invest in a long bond or CD? Investors get no dividends from AAPL, so the only way they make a profit is through growth of the company. Cash earning 2 or 3% is not going to produce the 20%+ growth that AAPL stockholders expect. That cash must be either distributed as dividends or applied to AAPL growth. The sooner the better - it would be nice if they don't have to take the MSFT route of offering a one-time $3 dividend that does nothing but knock $3 off the share price and incur taxes/reinvestment requirements for investors.
That being said, selfless promoters of growth stocks typically fail to heed what I consider to be the primary rule in economics - reversion to the mean.
Arguing over incremental tax benefits from option exercises is somewhat irrelevant from a value conclusions exercise. Value is determined by growth in excess of the a firm's economic costs of capital. There are way too many smart people out there paying attention to AAPL for me to waste any time coming to my own value conclusion. You all apparently have your own vehement opinions, which is all well and good. Just be cautious when trying to value future growth based on current valuations.
Also, to whoever the person was early in this bitter diatribe against the author that referenced AAPL's cash position as a rebuttal to overvaluation conclusions - cash is not an operating asset.
I've owned Apple since may of 2003 and people were always wondering weather the valuation is too rich.. I made 1000% since.
Apple is way more than calculating the number of phones sold... it's a brand!!!
This will hurt many loyal Apple VAR's and dealers who are being hurt by Apple stores already. Look for some specialized corporations to be hurt also by Apples move away from the Pro Market.