5 Reasons Apple Is A Bad Bet

| About: Apple Inc. (AAPL)

Many myths abound regarding Apple (NASDAQ:AAPL), not the least of which is that it is still cheap and a good buy at around $600/share right now. For those still undecided whether or not to buy Apple right now, here are 5 reasons why it might be prudent to stay away from the stock at the current price.

Reason #1: Growth is unpredictable.

Looking at Apple's historic earnings over the past 10 years, we see that although Apple's earnings have grown tremendously, they are far from predictable (see 10-year EPS data below, source from money.msn.com). The stock has grown its earnings-per-share (NYSEARCA:EPS) by 89% annually over the past 10 years (calculated by solving for x in 0.09(1+x)^9 = 27.68). If the stock can continue this rate of growth for the next 10 years, it would have $16098 earnings-per-share in 2021, or $15.1 trillion total earnings (based on 935 MM total shares on Apple's most recent balance sheet). If the stock sells at the same valuation of P/E = 14 as today, it would have a market capitalization of $211 trillion, almost four times the record high total market capitalization of all public companies in the world reached in 2008. Thus, to project Apple's growth rate would be absurd. In fact, it is difficult to say for sure whether the currently high earnings would not decline, given that Apple is competing in a rapidly changing technology industry.

Year EPS
2011 27.68
2010 15.15
2009 9.08
2008 6.78
2007 3.93
2006 2.27
2005 1.55
2004 0.34
2003 0.09
2002 0.09

Source: money.msn.com

Furthermore, looking at P/E using earnings for a single year is quite meaningless for Apple. 10 year P/E data is tabulated below (Source: money.msn.com). To wit: Apple had an average P/E of 89.8 in 2003 and an average P/E of 13.3 in 2009, but it was clearly a better buy at an average price of $8 per share in 2003 (multiply average P/E by EPS for 2003) compared to $121 per share in 2009 (multiply average P/E by EPS for 2009). Therefore, calculating P/E using current earnings or projected earnings can be misleading.

Year Avg P/E
2011 12.4
2010 15.1
2009 13.3
2008 24
2007 26.5
2006 29.2
2005 24.1
2004 38.8
2003 89.8
2002 112.8

Source: money.msn.com.

Reason #2: Conservative P/E is too high.

A more conservative method of calculating P/E, advocated by Graham and Dodd (please see Security Analysis), is to use average earnings over the past 5-10 years, which is very helpful to smooth out the cyclical nature of earnings). Using earnings averaged over past 5 years (see 10-year EPS data tabulated above), we get P/E = 48, at $600 per share. Using earnings averaged over past 10 years (this is also called "P/E 10"), we get P/E = 90. These valuations are way too high.

Robert Schiller, in his book Irrational Exuberance, demonstrated that returns for the next 10 years are inversely correlated P/E calculated using earnings averaged over the past 10 years, and that when stocks are selling above a P/E 10 of 25, future returns tend to be mediocre at best. A P/E 10 of 90 right now for Apple is foreboding and strongly suggests caution.

Reason #3: Price/book ratio is too high.

While single year P/E has shown to be a misleading indicator of value based on Apple's price history over the past decade, price/book ratio appears to be a better indicator (please see 10 year P/B ratio below; source from money.msn.com). The stock was a good buy in 2002-2004 with a low price/book, but was expensive in 2007 with a high price/book, subsequently correcting by more than 50% in 2008. The current P/B ratio is still very high around 5. The fact that Apple recently revealed plans to buy back shares is a big negative, because paying so much above book value at today's lofty price will be destructive to shareholder value. That Apple has decided to pay a dividend again in addition to buying back shares with its extra cash also means that it is no longer finding better investment opportunities to grow the company after an extremely successful decade.

Year P/B
2011 4.9
2010 5.6
2009 5.19
2008 5.11
2007 9.21
2006 6.59
2005 5.98
2004 2.88
2003 1.8
2002 1.29

Source: money.msn.com.

Reason #4: Blue-collar workers are mistreated in Apple sweatshops.

One of the 15 key criteria that Phil Fisher looked for in a common stock investment is good personnel relations with the company's employees on all levels. A good company should provide good working conditions for all its workers. Apple's sweatshop conditions in China, where many workers have committed suicide, is testimony to Apple contractors' harsh treatment of its blue-collar workers. By compelling high productivity and paying nominal salaries for its sweatshop workers, Apple might be able to generate high margins and profits in the short term, but unhappy workers will undermine the company in various ways that will ultimately cut into Apple's bottom line.

Although Apple has recently conducted audits, found violations, and begun to work on correcting its working environment concerns (please see Apple's Supplier Responsibility 2012 Progress Report here for more details), the violations uncovered are most likely only the tip of the iceberg of a rampant problem. There is never just one cockroach in the kitchen.

Reason #5: Executive compensations are way too high.

In 2011, Apple paid a total of $435 MM to its executives, of which $378 MM was paid to CEO Tim Cook alone. This is not only ridiculously high in absolute terms, but also totally out of line with what comparable companies pay for executive compensations. Apple's executive compensation is more than 3 sigma from the average of 15 largest US companies by market cap (inclusive of Apple), and makes up the largest percentage of market cap among all 15 large companies (see here for list of largest companies by market cap). It must also be pointed out that although Apple is the biggest US company by market cap, it is far from the biggest company by more traditional measures of assets and revenue, which are independent of the stock price. (Apple is #43 largest among all world companies by revenue and #177 largest among all world companies by assets.) Comprising 1.7% of earnings in 2011, Apple's executive compensation is even more than the expense ratio of many mutual funds. As executive compensations tend to only go up every year, Apple is a fabulous money printing machine for executives, at the expense of shareholders.

Values are in millions of US dollars. Data from morningstar.com. All executive compensation data are also readily available from proxy statements for the respective companies.


Apple is the biggest US company by market cap, but not by assets or revenue. At about $600/share today, the stock is too expensive. Given Apple's business model in the highly competitive and rapidly evolving technology industry, its growth is too unpredictable for a long term investment. Moreover, the company's business model requires intensive capital expenditures in research and development to maintain its competitive edge, and that it has recently decided to pay dividends again and buy back shares is ominous for future growth.

Lastly, Apple's outrageously high executive compensations is testimony to its true values: benefiting top executives, at shareholders' expense (not even to mention the poor workers in Apple's sweatshops in China). For all these reason, I believe Apple is bad bet for the long term.

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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