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Mohamed Abdirahman
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I am a MSc Economics students with a passion for financial markets and a particular interest in covering tech stocks. Besides this, I am actively engaged at a local investment club and also have my own investment portfolio with an investing experience of more than 6 years.
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  • Just How Cheap Is Apple At The Moment?

    Apple (AAPL), the world's largest company by market capitalisation saw its stock price decline almost 28% since the launch of the iPhone 5. Many were surprised how this decline could have occurred, given that the company released two wildly successful products, had more than $120B in cash and a P/E ratio of currently around 11.5X. This P/E is often compared to Google (GOOG) which is currently trading at around 21.25X earnings. In fact, Apple is currently trading at a discount of around 20% when compared to the average PE of the entire S&P 500. From this standpoint AAPL could very much be viewed as being cheaply priced.

    Proposed reasons for decline

    One question that arises is then, why such a company like Apple, which has had a tremendous growth over the past few years could be trading at such a low P/E and more importantly why it keeps declining. Two of the most widely proposed reasons is that it is mainly due to tax selling, in order to lock in capital gains at the lower tax rate and that hedge funds are shorting the stock excessively to artificially lower the price.

    When it comes to the tax selling argument, I would tend to disagree. Apple is one of the most widely held stocks by institutional investors. Hence tax selling by retail investors would not have such a large impact on the company, which at the time of its all time high was worth more than $660B. Tax selling by institutional investors on the other hand would have an impact. The problem with the tax argument however is that those with a bullish long term view would simply sell it and buy it back as soon as possible. Secondly, any institutional seller who would want to lock in gains would sell at the high and not wait at the sidelines to see the stock slide 25%. In fact, the first time the stock went to $505 was on 15th November 2012 (more than 6 weeks ago). Surely any institutional who wanted to sell for tax purposes would have done it by then and would have gotten back in by now. The tax selling issue, if this was a major cause for the stock decline should have been over by early December at the latest. However, we did see the stock price hit the $500 level in mid December and it was pretty much flat since then. This, I believe, implies that the tax selling issue has been overstated.

    As for the hedge funds and prop traders, one needs to bear in mind that this is the largest firm by market cap. The sheer size of it would make it unlikely that any hedge fund would have enough fire power to significantly affect its pricing over such a long time period. In fact, short interest in AAPL is currently around 2% of the floating shares which is an increase from around 1.5% in September. At the all time high, this 1.5% short interest would have been around $10B, hardly enough to bring the company's market cap down by $180B.

    The low Price/Earnings multiple

    Back to the initial question if AAPL is currently undervalued. The problem with the P/E ratio is that its interpretation is ambiguous. Thus, a low PE can be interpreted as the company being cheap, that investors are losing confidence in it, or simply that the market is willing to pay less dollars per dollar of earning that the company generates. Exxon Mobil (XOM), the second largest company by market cap is trading at a P/E of just 8.99X but this does not imply that it is cheap. In fact it is in line with other petrochemical manufacturers.

    When comparing AAPL, many people often compare it to companies like GOOG, Amazon (AMZN) or Microsoft (MSFT), all of which currently have a higher P/E ratio than Apple. Although there is some competition between them, comparison between AAPL and those firms is not very meaningful. Almost 50% of Revenue and 60% of profits at AAPL come from the iPhone. Since none of the three companies above manufacture smartphones we should instead compare it to other smartphone vendors.

     

     

    Top 5 Smartphone Vendors Q3/2012 (Smartphone Units in millions)

       

    Vendor

    Q3/2012 Unit Shipment

    Market Share

    Q3/2011 Unit Shipment

    Market Share

    YOY change

    P/E

    Relative*

    Market Cap (US$)**

    Samsung

    56.3

    31.3%

    28.1

    22.7%

    100.4%

    11

    0.72

    210B

    Apple

    26.9

    15.0%

    17.1

    13.8%

    57.3%

    11.54

    0.81

    479B

    RIM

    7.7

    4.3%

    11.8

    9.5%

    -34.7%

    -

    -

    6.2B

    ZTE

    7.5

    4.2%

    4.1

    3.3%

    82.9%

    20.82

    1.44

    5.3B

    HTC

    7.3

    4.1%

    12.7

    10.3%

    -42.5%

    9.39

    0.4

    8.8B

    Others

    74

    41.2%

    49.9

    40.3%

    48.3%

    -

    -

    -

     

    179.7

    100.0%

    123.7

    100.0%

    45.3%

    -

    -

    -

    Source: IDC Worldwide Mobile Phone Tracker

    * P/E relative to their local benchmark index

    ** USD Market Cap for non-US Vendors have been converted using exchange rate as of 30/12/2012

    Although it is often said that Apple competes with Android (and perhaps Windows Phone 8), the fact is that Android or Windows Phone are only operating systems. Therefore Apple should be compared with other smartphone vendors and in particular the other Top 5 vendors. These are namely Samsung (OTC:SSNLF), Reasearch in Motion (RIMM), ZTE (OTCPK:ZTCOF) and HTC (OTC:HTCCY). From the table below we can see that the P/E ratio is generally low across the top 5 vendors, ZTE being the exception which could be due to the fact that ZTE's primary business is not in consumer goods. RIM currently is making losses and hence a P/E cannot be calculated. However, even RIM had a P/E of around 6X prior to posting losses in Q1/2012. We can also note that all but ZTE trade at a discounted P/E in comparison to their local benchmark index.

    Of course one could dispute the comparability due to the huge market cap difference and the different growth rates. In this respect, Samsung is the most likely firm for a close up comparison which has similar growth rates (both in revenue and profits) and is also AAPL's toughest competitor in the smartphone and tablet market. Note that Samsung trades at a deeper discount to its benchmark than AAPL and also has a lower P/E ratio despite being up 44% over the past 12 months, compared to AAPL which is up only 26% over the same time period. From this perspective, AAPL does not look cheap, but rather in line with their main competitors in the smartphone market. The reason why smartphone vendors seem to carry a relatively low P/E multiple, I believe, has to do with the nature of smartphones. Given that consumer preferences can change swiftly [see Nokia (NOK) and RIM] it is nearly impossible to meaningfully project growth beyond a 1 year period. If you attempt to estimate 5 year growth rates you will need to bear in mind that 5 years down the road the consumer electronics industry might change to a degree that incumbents could see themselves marginalised. Apple and Samsung are no exception to the rule.

    (click to enlarge)

    In fact, a P/E of around 11.5X seems to be what the market is willing to pay for AAPL. The chart above shows the P/E ratio for AAPL over the past 4 quarters. Note that the current P/E is almost exactly as AAPL's P/E ratio in the same time last year. The rise in the P/E during the year can be interpreted as heightened expectations for the firm. In fact, only 90 days ago, the average EPS estimate for the fiscal year ending September 2013 was $53.30 per share. At that EPS and the multiple that the market seems to be willing to pay, the company would have traded at around $610. Allow for the possibility that investors were used to AAPL beating analyst estimates and you have the $700 where AAPL was trading at in September (a 15% premium to the mean analyst estimates in expectation of a beat). Of course this beat did not materialise and hence the selloff in the stock.

    EPS Trends

    Current Qtr.

    Next Qtr.

    Current Year

    Next Year

    Dec-12

    Mar-13

    Sep-13

    Sep-14

     

    Current Estimate

    13.33

    12.18

    48.81

    57.35

    7 Days Ago

    13.3

    12.18

    48.87

    57.35

    30 Days Ago

    13.3

    12.41

    49.28

    57.95

    60 Days Ago

    13.59

    12.5

    50.46

    59.05

    90 Days Ago

    15.44

    13.17

    53.3

    61.13

    Source: Yahoo Finance

    Conclusion

    While AAPL looks undervalued, based on P/E ratio among others, a closer look shows that it is in line with multiples among its closest competitors. Tax selling and hedge funds which have been blamed for the fall in the stock price might not have played such a big role. I believe it is more likely that the market was correcting following increased expectations for earnings which have not been met. In terms of future outlook, any new investor should not buy above a (trailing) P/E of around 10-11X as this seems to be as much as the market is willing to pay for AAPL's future earnings, which is also in line with the smartphone industry. Signs to look out for in the stock would be declining growth and possible P/E compression in case the market outlook for the firm continues to decrease.

    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.

    Dec 31 7:41 AM | Link | Comment!
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