Don't Avoid Apple Just Because You Are Afraid Of Losing Money

| About: Apple Inc. (AAPL)

Two months ago, Apple (NASDAQ:AAPL) was in the low $400s as it approached its quarterly earnings. After a great report, the stock rocketed higher, and it has gone upwards since then. We all wondered how soon it would break $500, and it did that pretty easily. Now, it has $600 in its sights, and it seems to rise almost every day.

Apple is up more than 40% so far in 2012, and I get the feeling that some investors are getting worried. They have avoided buying Apple, missing all of this run, and are afraid to get in at higher and higher levels. This is a logical fear. When you see a stock rising like Apple is, you begin to feel that it will drop as soon as you buy it. So you avoid it, afraid of losing money, and that is your biggest mistake.

If you are scared of buying Apple at these levels, don't be. Here are some reasons why you shouldn't be afraid, and some things you can do to make money if you are afraid to get into the name.

So much for the pullbacks:

If you are afraid that Apple will drop as soon as you buy it, look at just the past few months.

  • When Apple initially released earnings, it traded as high as $468 and spent most of that afternoon/evening in the $455 to $460 range. The next 3 days, its low of the day was just above $443. Two weeks later, we were at $490.
  • On February 15th, Apple, which closed at $509.46 the next day, seemed to go "parabolic" when it rose above $526 at the day's high. Then, the stock tumbled, with a low under $497 and closing just a dollar off its low. The next day, Apple fell under $487 at its low. A week later, it was back to $516.
  • On March 1st, Apple hit a new high of $548.21. The following Tuesday, the day before the iPad announcement, Apple dropped as low as $516.22. The next day, when it announced the new iPad, the stock traded as low as $523.30. A week later, it traded as high as $594.73.

There were three pullbacks there of at least $25 to $30, and each time, the stock ended up higher in the end. Even if you buy it, and it drops say $20 in the next few days, percentage wise at these levels, that is less than 3%. You are buying this for its long term growth, so jumping ship after a small loss at the start would be unwise.

The Valuation is Reasonable:

Okay, so Apple still isn't that expensive. Think about this comparison, Apple to Microsoft (NASDAQ:MSFT). Apple's gross margins trail Microsoft's, thanks to the high-margin software business. However, Apple has been increasing its margins quite a bit lately. Look at the following table.

Gross 76.38% 42.41%
Operating 38.04% 33.87%
Profit 32.57% 25.80%

Despite Apple being way behind in gross margin percentage, its operating and profit margins are much more comparable to Microsoft's. Don't forget, Microsoft's margins are coming down now, as they sell lower margin products, such as the Xbox. Apple's margins are going up now, so expect the gap to narrow going forward.

Now, when we get to valuation, I look at the following numbers, which I've compiled in the following table. Apple is actually cheaper than Microsoft on a price to sales basis, and gets even cheaper if we go out to 2013. Now remember, Microsoft's fiscal year ends in June, and Apple's ends in September, so there is a difference there. However, even on a P/E basis, Apple isn't trading too much higher than Microsoft, and look at the growth you are getting. I also expect Apple's earnings per share to grow a lot more than 11.5% in fiscal 2013, analysts are extremely conservative right now.

Current Year Revenue Growth 5.70% 45.40%
Next Year Revenue Growth 8.00% 16.30%
Current Year EPS Growth 0.00% 54.95%
Next Year EPS Growth 11.90% 11.49%
Valuation MSFT AAPL
Current Year Price/Sales 3.72 3.49
Next Year Price/Sales 3.44 3.00
Current Year Price/Earnings 12.18 13.75
Next Year Price/Earnings 10.89 12.33

Try Some Options Trades:

This may shock some people, but you can make money in Apple without owning a single share. Options trades can generate nice profits as well, and can generate larger percentage returns. They do carry a high level of risk, so you need to be knowledgeable about these trades if you want to succeed. Some of these trades also require you to use margin and post some collateral, so know what requirements each options trade may carry. Here are just a few recommendations I have for some Apple options trades.

  • If you think Apple just goes higher from here, consider selling some puts. You could sell a May expiration $570 put for about $25.50 now. If Apple is above $570 at expiration, you pocket that money, unless the stock falls below the $570 level before then and the option is exercised. If the option is exercised, you are forced to buy those shares at $570. However, since you received $25.50, you are essentially buying Apple at $544.50 (not including commissions for simplicity).
  • If you think Apple might pull back a little from here, you could buy the April $595 for $30. However, I would recommend that if we get a quick, sharp pullback, like one of those $10-$15 intra-day drops, take profits in this one, and quick. Apple can quickly rebound, and your $3 gain can become a $3 loss in an hour. If you manage to sell at a profit, you might want to consider selling puts, like I mentioned above. Say Apple drops to $570. You could possibly sell the May $550s for $25 and follow the same logic as above.
  • Try a call spread. This trade involves buying a call, and selling a higher strike call. For instance, lets look at June expiration options. You could buy a $590 call option for $40.10 and sell a $660 call for $16. This trade costs you $24.10 in total. If Apple is above $614.10 at expiration, you can make money all the way up to $660. Above $660, the call you sold is exercised, forcing you to sell shares at $660, buy you have your $590 call allowing you to buy at that price. You would have a $70 gain minus the $24.10 cost. It's a decent risk to reward trade if you think Apple will be above $614.10 by June 15th. For those that might seem confused, the following chart shows the profit/loss per contract given Apple's price at expiration.

Buy An Apple Supplier:

No, I'm not saying here that Apple should or will buy one of its supplier. What I am saying is that there are a few companies that supply Apple you can make money in. I'll give you three names I like, but know there are others out there as well.

Qualcomm (NASDAQ:QCOM): One of Qualcomm's primary lines of business is mobile chips that go into smartphones, one of which is the iPhone. Qualcomm is expected to show 29% revenue growth in the current fiscal year (same one as Apple's) and 12% next year. Earnings per share are expected to rise 17% this year and 10.4% next year. Qualcomm also offers a 1.3% annual dividend. If you believe the iPhone will do well, and that Apple will launch the iPhone 5 this year, this is a name that will do well for you. Buy this stock if it falls back into the low $60s, but you could start entering your position at these levels.

Nuance Communications (NASDAQ:NUAN): Nuance provides voice and language solutions and service. In terms of the iPhone, Nuance is the company behind Siri. Nuance is expected to grow revenues by 20% this fiscal year (same as AAPL, QCOM) and 15% in the next one. Earnings per share are expected to rise 14.4% this year and 10.7%. This company does more than just Siri for the iPhone. The company also deals in medical transcription and speech editing services.

Again, if you are a believer in the iPhone, Nuance is a good bet. I would expect the iPhone 5 to have Siri, and that will help Nuance going forward. The company trades at just 15 times next year's earnings, a fair valuation for a company with this growth potential. Nuance declined after last quarter's earnings report wasn't great. I think the stock has come down enough, and that expectations have come down too, leading to the potential for future beats. I like the name at current levels, but if it falls below $25, add to your position there.

Corning (NYSE:GLW): Corning makes gorilla glass, which is used in the iPhone. Recently, Apple hinted that Corning makes the majority of the glass for the iPhone. Expectations for Corning have come down in recent months after disappointing guidance from the company earlier this year. Average analyst estimates for this year (December ending) have dropped from $1.71 to $1.36 over the past 90 days.

Next year's forecasts have come down by a quarter to $1.50. But given their supply for the iPhone, Corning could be a great investment. Additionally, the company manufactures glass substrates for liquid crystal displays (LCDs) for notebook computers, flat panel desktop monitors, and LCD televisions. The company also pays a 2.2% dividend. Corning's stock shows support around $13, so I would buy around that level, perhaps lower if you can get it there.

Conclusion - You can make money!

Just because you've missed the rally in Apple so far doesn't mean you should avoid the name. You can still buy Apple on pullbacks. On Wednesday, Apple pulled back to $576 intra-day, and if you bought there, you were up about $13 by the closing bell. Apple still maintains a decent valuation, so there is room for growth. Of course, you can always try an options trade if you want to get in on a smaller scale, with a little more risk of course. If you already own Apple and are looking for more exposure, buy some of its suppliers. They will rally too.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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