Apple (AAPL) has peaked.
The closing price of $702.10 on September 19, 2012, representing a $660B market cap (the highest nominal value ever for a public company), will be noted with nostalgia over the next few years. In the meantime, sit back and enjoy the marvel that is AAPL. Enjoy the heyday of a company whose innovation and influence have changed the world and amazed analysts and investors alike. Just don't invest in that company.
With an opening paragraph like that, one might expect a sensationalist tone to ensue, but that is not the intent of this article. The purpose of this article is to rationalize - to point out exactly what has driven AAPL's incredible share price performance, and why that impetus is on the decline. This doesn't mean that AAPL's mystique will not persist or that its products won't ring Christmas trees for winters to come.
It does mean that the market is unforgiving. But you already knew that.
Irrelevance of Traditional Valuation Techniques:
The circumstances surrounding AAPL's share price trajectory are unique in the history of modern companies. Dot-com era MSFT is probably the best comparison one can offer. MSFT was a tech company that managed to conquer a large market and establish an enduring ecosystem (sounds familiar). But the AAPL of recent years and the MSFT of the 1990s achieved their high absolute valuations in very different fashions, a fact which underscores AAPL's one-of-a-kind nature.
AAPL's share performance is unique for two reasons. First, the company hasn't had the benefit of a valuation bubble. When MSFT peaked in December 1999, its P/E (TTM) stood at a robust 77x. AAPL's P/E sits at 13.5x and hasn't been valued at more than 20x forward earnings since mid-2008. Despite the multiple compression, AAPL's market cap over the same period increased by a factor of 7.
The causes for what seems to have been an absurdly low relative valuation are to AAPL's credit. Its products were so innovative and forward-thinking that analysts had a hard time imagining how they might be used by consumers. And when analysts eventually understood that consumers would buy the products, they underestimated just how many would be sold. The growth rates and profit margins were unheard of. There was no time for a valuation bubble to develop - this was an earnings bubble!
AAPL's rise is also unprecedented because it occurred in our present-day 24/7 media environment. The rise of social media, blogs, mobile computing and the like (Seeking Alpha included), combined with more traditional sources like CNBC, has had the effect of shining an ever brighter spotlight on the world's most successful company. No other company has come close to the level of scrutiny and adulation. Every investor has an opinion and, perhaps just as importantly, can act on that opinion with a tap of the finger. AAPL is the stock market's version of Michael Jordan (circa 1993), Tiger Woods (circa 2000) and Roger Federer (circa 2006) all rolled into one - but back then, those guys didn't have to deal with today's ever-expanding media circus.
The ultimate result of the earnings bubble (and I don't mean the phrase to be negative) and this pervasive investor interest is that AAPL doesn't trade on valuation. A hundred million dollar company (which it was in 2009) just doesn't grow EPS 45% YoY - much less for 3 consecutive years (CAGR). A PEG Ratio of 1 (thought to represent a fair valuation technique for many companies) using a trailing 45% CAGR would value AAPL north of $1.8T. That's ~12% of U.S. GDP. Many investors have done the same or similar calculations and used the results to justify an investment in AAPL.
I take a different approach. I believe that the takeaway from such calculations is to conclude that AAPL trades independently of commonly used valuation techniques. Three years of price action has convinced me.
So if not typical valuation methods, what drives AAPL's share price? In my view, it is the same factor that exerts an influence on the prices of nearly every other stock - it's simply more muted in those cases. AAPL's share price is almost exclusively a product of investor sentiment.
If you are reading this article, it is likely that you don't believe in efficient markets. The moods and whims of the investing public, the collective perception of a particular company, regardless of fundamentals, can and do move share prices. For most companies, residing in the shadows cast by giants like AAPL, the effect is minimal. For AAPL, it is the only effect.
Gauging Investor Sentiment and Recognizing the Peak:
To identify AAPL's peak, we must identify the peak in sentiment, but if history is any indication peaks are notoriously difficult to pinpoint. In hindsight, it should have been obvious that MSFT at 77x was ridiculous, that Tiger and Federer couldn't keep winning Majors and Slams, that gravity would take its toll on MJ. I would bet, however, that a survey of interested observers during each of their respective peaks would show that most people thought the best years were ahead. After all, these high fliers (sans-MSFT) continued to compete at a high level for years afterward.
That doesn't change the fact that each, in hindsight, had reached peaks in public sentiment. Notice I say sentiment, as opposed to an objective peak. The actual peak precedes the peak in sentiment. Humans are stubborn and will defend their heroes. A bad day, a bad game, a bad earnings report (or 2 in AAPL's case) can be explained away. Often, these events are warning signs that the objective peak has been reached, and the peak in sentiment will soon follow.
If investor sentiment is the guide, then there are ways it can be measured. While some will argue that investor sentiment in support of AAPL can move higher, I respond that it is already at frenzied levels. I get more Seeking Alpha alerts, see more tweets, read more blogs, and watch more CNBC coverage about AAPL than the rest of the S&P 500 combined (maybe a slight exaggeration - but not by much). These frenzied levels are particularly high around product launches, and it is not surprising to see that AAPL's peak occurred the week after the iPhone 5 unveiling (and immediately following robust pre-order numbers).
Detractors will point to prior product launches that were no different, and the subsequent share price movement upward, many after pullbacks, is evidence that the stock will continue its climb. I argue that this time is different. The iPhone 5 is projected by some analysts to sell more than 200M units (using the formula: iPhone 5 unit sales > all prior iPhone versions). At an ASP of $625, that's $125B in revenue for a single product over the course of a year or so. If that isn't indicative of extravagant investor sentiment, I don't know what is.
Outsized sentiment alone, however, would mean very little without warnings signs. By now, we should be seeing cracks in the foundation. I believe they are there, although sometimes difficult to identify amidst the cacophony of analyst support.
Some are obvious. Over the past 30 quarters, AAPL has missed estimates only three times - all three misses occurred in the last five quarters. Steve Jobs is no longer at the helm. From a hardware perspective, the last two iterations of the signature iPhone have been met with (or preceded by) technologically equal or superior competitor products.
Others are less obvious. The diversification of the product line into lower margin products, whether it's the iPad mini or more expensive iPhone 5, is beginning. A real iTV (not the current Apple TV) has yet to materialize. Significant emerging markets, e.g. India, remain stubbornly resistant to AAPL products. And why has the long rumored China Mobile deal not yet come to fruition?
Perhaps even more telling was observing the reaction to AAPL's FY Q4 earnings this past week. I was struck by the emotion and vehemence of sell-side and buy-side apologists alike. iPads lagged because of the prior quarter's inventory build-up and rampant rumor speculation. Guidance was terrible because that is just what AAPL does, never mind that earnings have increasingly been coming in-line with guidance (within 15% the last two quarters). According to these analysts, competitors still haven't caught up - "Windows 8 is a joke," said one analyst. And then, of course, the "compelling valuation" for a company that is already the most valuable in the world by a factor of 1.5x.
Nothing Lasts Forever
Nothing lasts forever, and the investment of the last decade will not be the investment of the next decade.
AAPL's headwinds are many and varied. Its history of earnings beats brings sky-high expectations. Its products are fundamentally consumer-oriented and lack ideal stickiness (the ecosystem is great, but iOS and its back-end programs are not comparable to Windows and Office when it comes to customers contemplating a switch). The consumer electronics industry is rife with competition and riddled with the corpses of giants past (NOK / RIMM come to mind). Moreover, the company is so big and successful that it has become the target for handset manufacturers, wireless carriers, cable companies, and internet giants (GOOG / AMZN) alike - sometimes working in concert (not to mention regulators).
But you knew all of that. AAPL will overcome - it always has.
Or will it? The free market is defined by nothing if not competition. In recent months, AAPL sentiment has never been higher, yet the warning signs are multiplying.
AAPL is a victim of its own success. It has peaked. To its credit (and it deserves a lot), AAPL will remain the best company in the world for some time - perhaps years.
It just won't be the best stock.
Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in AAPL over the next 72 hours.