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Why Apple's Q4 Earnings Miss is a Good Thing for the Stock

In 2011 Apple's stock had become a victim of the company's success.

Market expectations became so unreasonably high that Apple had to come in with blow-out earnings every quarter just to keep the stock from dropping in price!

Apple delivered blow-out earnings results in January, April and July of this year, but the effect on the stock was actually negative.

Let's take a look at what happened after each earnings release:

  1. On January 18, 2011 Apple reported an EPS of $6.43 which came in 19.52% higher than street consensus, and 75.25% higher than the previous year. On January 18 the stock closed at $340.65 - the next day it closed at $338.84 - 23 trading days later (Feb.22) it was trading at $338.61.
  2. On April 20, 2011 Apple reported an EPS of $6.40 which came in 19.63% higher than street consensus, and 92.19% higher than the previous year. On April 20 the stock closed at $342.41 - the next day it closed at $350.70 - 22 trading days later (May 24) it was trading at $338.19.
  3. On July 19, 2011 Apple reported an EPS of $7.79 which came in 34.08% higher than street consensus, and 121.94% higher than the previous year. On July 19 the closed at $376.85 - the next day it closed at $386.90 - 22 trading days later (Aug.19) it was trading at $356.03.
Of course there were other factors which effected the stock price - the perpetual Euro debt crisis - the US credit downgrade - the worries about Steve Jobs' health - but the fact remains that market expectations for Apple had become unsustainably high.

This is why Apple's miss on Q4 2011 earnings is so significant.
 
Note: Apple actually beat their own estimates for the quarter by a wide margin - they had forecast an EPS of $5.50 and came in at $7.05 - but nobody really pays any attention to this.

Yesterday's earnings miss has burst the delusion bubble of street expectations for Apple. Going forward the company will no longer need to come in with blowout earnings in order to satisfy the street. And this is good for the stock. Lower expectations means that Apple can now modestly exceed market consensus numbers and the stock will actually surprise to the upside after earnings instead of going south. If they come in with blow-out earnings (which is no longer the expectation) the stock wil explode to the upside.

Today's sell-off in Apple is healthy for the stock going forward (down 3.79% to $405.49 at the time of writing). It has broken the pattern that has suppressed the value of the stock after each earnings report in 2011.

We expect the stock to consolidate around the $400 level and then begin a slow, gradual climb to $450 by Christmas. The math is simple. The company reported earnings of $7.05 for Q4 and the stock is at $405. Apple, which usually provides conservative guidance, forecast revenue of $37 billion and EPS of $9.30 for Q1.

So if the stock is at $405 today with earnings for Q1 expected to rise 31% quarter over quarter, and 44% year over year, why would you want to sell the stock today?

Add to this earnings growth rate the fact that Apple has $81 billion in cash and is trading at a rather conservative forward P/E of 12.74 and it doesn't make any sense to sell the stock at this level.

But stocks do not trade on fundamentals alone. Macro-economic events can push Apple lower along with the general markets. And if we do see the general markets fall due non-Apple issues I think that the following price points would be excellent entry levels into the stock if you don't own it, and good price points to add to any existing positions.

The first level of technical support for Apple is at $390. If $390 doesn't hold then the next support level is at $375. Given the company's fundamentals if it does drop to $375 it won't stay there for long. These are the price points at which we will be adding to our current Apple position (see chart below).

Market psychology is just as important as fundamentals when it comes to the price of a stock - and today the market psychology for Apple improved for the better.


Click to enlarge

Disclosure: I am long AAPL.