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Fundamentals:

Since mid 2011 Apple (NASDAQ:AAPL) has established a new TTM P/E multiple trading range of approximately 14-16x earnings with an average of 14.83 over the past 12 months. In the past 437 trading days the stock has only been under a 14.0x TTM P/E multiple for 75 days (including the current streak of 4). The longest streak under the 14.0x P/E mark was in January 2012 and May 2012 and was 17 trading days in both cases. The big January decline was due to the EPS blowout and it took the market a couple weeks to re-establish the range by running the stock price up. 14x the current P/E of 44.15 would be $618 a share, so I expect the stock to recover to the 620 range relatively quickly.

I have personally been trading this range for the past year and half or so and have made millions, particularly on the Nov '11 dip. The 16x top end of the range gives you a reasonable and good reason to exit while the stock is still hot. On the most recent run up you would have exited at 680. You would have missed 20 more points on the way up, but avoided the disastrous 100 point drop afterwards.

Many investors and statisticians are familiar with the concept of mean reversion. That was the premise that the popular pair trading theories were based on. If the new mean is approximately 15x PE then the stock should recover to the 660 range as a mid-point. In fact, AAPL has vacillated in the 14-16x P/E range so much over the past year that every time the stock broke the lower range of 14x it recovered approximately $100 a share within three months, expanding back beyond the 16x band on the upper side.

Here is a graph of the daily TTM P/E multiple along with the stock price:

(click to enlarge)AAPL PE Ratio

In January AAPL is likely to show EPS growth over the year ago period (especially with all the new product refreshes and more global launch), so the 14-16x trading range would be even higher then when applied to the incremental EPS over the year ago period.

How do we know that we aren't establishing a new trading range? Well, if it did establish a new trading range AAPL's P/E ratio would then be ridiculously low relative to other stocks given its consistent high growth, cash on the balance sheet, cash conversion cycle, ultra-powerful brand, high net income margin, and extreme product demand. If AAPL's P/E multiple were to establish a lower range than it's in now, I would challenge anyone to find a better stock. Look at some other stocks and their P/E multiples:

Google (NASDAQ:GOOG) at 21.55: AAPL is 37% cheaper on a P/E basis and is growing EPS at 20%+ YoY vs. Google's <10% growth.

Microsoft (NASDAQ:MSFT) at 15.95: AAPL is 15% cheaper on a P/E basis and MSFT is barely growing EPS.

Take into account Apple's brand power, powerful ecosystem, virtual monopoly on digital content sales, massive margins, and cash hoard, and this gap widens even larger.

Finally, the stock is being beat up for no particular reason. Apple has more demand than they can supply. Last I heard, that was a good problem. People should start worrying if demand wanes. Would you prefer to have them crank out product and have it sit in inventory because no one is buying it? With nearly all of their products refreshed early in the holiday quarter and a much broader global launch, this is clearly going to be a monster quarter. People argue about the popularity of the iPhone and iPad mini and Apple's innovation, but the products are sold out - look at the shipping times on their site and what carriers are saying. Why dispute the hard data. The only quantitative way to measure innovation is demand, and I think Apple wins that argument hands down.

I think the P/E ratio will hit the 16x top range again before the January announcement, which translates to another $700 stock price. I think we've hit the fundamental floor and we're about to see the turn and momentum increase. Right now the average analyst estimate for next quarter is lower than last year, which is absurd given the product refreshes (especially the iPhone) early in the quarter and unprecedented global rollout. The analysts will be increasing their estimates for the quarter and that will only help spark the upward momentum we're about to see.

Technicals:

I'm not a huge market technician, but I do use them as a secondary check after fundamentals. I personally prefer the slow stochastic oscillator and the MACD. The slow stochastic is less than 15 and pretty close to its two (and even five) year lows. Other times it has been that low the stock has gone on to gain 100 points within the next 2-3 months.

The MACD is near a 5 year low and we should see a positive crossover relatively soon, triggering a buy signal. I don't put a lot of weight on technicals, but I do look at them directionally. Directionally, they scream oversold. This just confirms that the stock is poised to surge in the next few months.

Overall, the stock is oversold going into the best quarter in the company's history. I generally look to buy below 14x and sell above 16x TTM P/E and given the current multiple of 13.5x the stock is at bargain basement levels. Given the strong fundamentals, new product releases, product demand, cash position, recent dividend, patent case wins, and most likely the Jan announcement of the best quarter in Apple's history, I expect the stock to hit a 16x TTM P/E again before January, which would re-test the current high of $705 hit just a month and a half ago.

Source: Expect Apple To Surge In Coming Months