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I am a two-decade veteran of the investment business and am especially interested in technology investments.
  • Everyone Knows Apple is Cheap, So Why is It? 0 comments
    Nov 21, 2011 11:15 AM | about stocks: AAPL
    If I could collect a penny for every word that has been written about the disconnect between Apple's business execution and its stock price, I would be so rich that I could quit pondering this question. Since I am not entitled to such royalties however, I must seek answers that go beyond the more easily-offered explanations. It may be impossible to reach a consensus opinion here, but this site is the perfect forum for such an inquiry.

    There is no doubt that Apple investors are frustrated by the failure of the market to reward what Apple owners feel has been exceptional business execution by the company.  As Apple's product successes have piled up, its p/e has come down, an indication that investors are becoming less and less willing to pay for each dollar of Apple's sharply rising earnings.  Why is that?  Why are investors so unwilling to accept the proof that has been put before them every three months for the better part of the past decade?  I daresay that a better macroeconomic environment would have made investors less circumspect, but Apple, despite its execution, has not escaped the investor anxiety brought on by a decade of financial and economic turmoil. 

    Many of the reasons have been discussed at length.  For several years, the issue of Steve Jobs' health was the accepted reason that Wall Street would not accord Apple a price commensurate with its performance.  Well, we are in the process now of jury deliberation and an initial verdict on that issue should be returned in February with the release of Q1 earnings.  Despite the fact that these three months really will tell us almost nothing about Apple's ability to execute without Jobs at the helm, the scrutiny on the company is intense.

    Another popular theory is that Apple is viewed as a "trendy retailer."  When the fickle consumer finds something that it thinks is cooler than whatever it is that Apple sells, Apple will be left with no end market for its products.  Personally, I think this is ridiculous, as Apple has proved quarter after quarter that its products continue to be in high demand.  Furthermore, Apple's progress with its enterprise initiatives indicate that those who once derided the iPhone as a toy and the Blackberry as a tool for business now are rethinking that bias.  Corporate IT executives who misunderstood Apple's simplistic design ethic are realizing that simple is better and that a simple design is infinitely harder to achieve than a complicated one.

    The refusal of Apple to pay a dividend is a popular theory. I spoke last summer with a hedge fund manager who had a substantial Apple position and he was apoplectic about Apple's refusal to share its cash with shareholders.  He has since trimmed his Apple position substantially. Apple has about $81 billion in cash + long- and short-term marketable securities, more than enough to pay a decent dividend that would–as the theory goes–bring in those investors who invest only in dividend-paying stocks and bring back those who sold because of Apple's cash management policy.  The problem is that Apple really does not have $81 billion lying around.  I read last night that more than $50 billion is "trapped" overseas in the form on unrepatriated earnings, earnings that would be subject to as much as 35% corporate taxation were it to be brought home.  Without going into the ridiculous tax policies that have allowed this, the fact is that Apple is sitting on a big unpaid tax bill.  There is a movement afoot to grant tax amnesty to these earnings so that this money can be brought home and put to work, but until this issue is resolved one way or another, don't expect Apple to announce a dividend. I will concede that Apple seems to have little in the way of a reasonable defense regarding its cash hoarding.  The company earned less than 1% on its cash last year. Certainly there are better uses for that cash but whether Apple's cash management policies are responsible for a lagging share price is debatable.

    Competition.  Since monopolies are illegal in this country, all companies face competition.  Apple is such a company.  It defends its intellectual property viciously, knowing that its ideas and designs are its best weapons in the competitive markets in which it participates.  Every company with an interest in telecom and computing is attempting to one-up Apple's success with products of their own.  Sales data offers conflicting evidence as to whether these companies are making meaningful progress.  After years of effort, other companies eventually conceded the mp3 market to Apple.  iPods continue to make money for Apple and serve as an important entry point to the "Apple experience" to the youthful consumer, but Apple's future is tied to the iPhone, the iPad, and perhaps Apple TV and the various products that spring from Apple's efforts in that segment.  The various smartphones that use Google's Android software do offer plenty of competition for Apple.  Apple currently owns the tablet computing market, but not because of a lack of effort from competitors.  The iPad has the very important "first-mover" advantage and is the tablet by which all other tablets are measured.  Whether or not tablets are the future of computing is still a point of debate but for the moment Apple is defending its tablet dominance against all comers. 


    Apple currently is in the uncomfortable position of having minority market share and a huge market cap, a dichotomy that investors find troubling.  Apple proponents point to the minority market share in computing and telecom as evidence of the potential for continued growth while Apple doubters point to the market cap and say that Apple's ability to grow is just about over. The market cap argument has been bandied about for a few years now but, as with the "trendy retailer" argument, I find that this one lacks credibility.  Apple already is priced as a slow-growth or no growth company.  Apple has a trailing p/e of 13.90 including cash (10 ex-cash) but last year delivered earnings growth of 83%!  As hard as this may be to believe, Apple has delivered 65% annual earnings growth over the past five years.  Apple investors will tell you that they have not been suitably rewarded for this growth, as the market has only been willing to pay as much as 20 X for that growth.  The geniuses who follow Apple for Wall Street currently are expecting Apple to earn $34.65 in this fiscal year, growth of 25% over last year's $27.68.  Apple's p/e based on these estimated earnings of $34.65 is 10.6 (including cash) and is 8 if you subtract $90 in cash from the current price of $368.  That is absurd.

    Apple is known as a source of funds because of its huge capitalization. Mutual funds and hedge funds own large quantities of the stock. These funds can sell large blocks of the stock without causing too much downward pressure on the stock price. When funds are chasing performance and want to try to milk a few percentage points from an up market, they buy Apple. Likewise, when the storm clouds gather, they sell Apple, buffeting the poor individual investor who is trying to maintain a long-term perspective. If hedge funds really can manipulate the stock in the hope of driving down the price, how much more downside can they want from here?

    So, the question remains.  If Apple is unversally acknowledged to offer the best growth and the cheapest price in the mega-cap universe, why then is every investor not loading up on the stock?  The downside risk at these levels seems to be miniscule, but if investors are willing to let Apple trade at a 10 p/e, is there any reason to believe that it cannot get cheaper?  Fundamentals apparently don't matter here.  Technicals also seem not to matter, as Apple currently is at least two standard deviations down, a level that suggests an extremely oversold condition.

    No, there is something else going on.  Is it the stock price itself?  Is the fad of the high-dollar stock price losing its cache?  Despite price targets several hundred dollars higher than the current stock price, Google has been trying to get past the $650 level for two years now.  Same with Apple.  $400 seems to be a level above which investors have a hard time buying the stock.  Eventually, earnings growth will push us past this level, but Apple currently is worth much more than $400 per share in my opinion.  All analysts agree, yet investors refuse to participate.

    Apple currently sits on its 150 moving average, an indicator known as the "smoothing mechanism" by renowned technical analyst Carter Worth of Oppenheimer.  This smoothing mechanism often acts as support for stock prices and it would appear that this $360-370 range is what the "professional" investors have been targeting.  Now that we are here, will these pros step in or are events in Europe overtaking any desire to buy Apple at this level?  At some point fundamentals will matter.  I believe that we are at that level now.  RIGHT NOW.

    My perspective comes from having closely followed this stock for almost a decade.  I read Seeking Alpha for the chance to gain perspectives that I may not have considered.  Apple's price action has confounded me.  Stock usually climb a wall of worry. Not Apple.  In Apple's case, the worries seem to trump any of the positive expectations for the stock.  I have never seen anything like it. 
    Themes: value investing Stocks: AAPL
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