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IT Looks Overvalued Without Apple

|About: Apple Inc. (AAPL), Includes: XLK

Apple (NASDAQ:AAPL) has retreated significantly recently, the rationale for the decline has been debated, but something that cannot be debated is its influence over the technology sector (NYSE:XLK). To quantify this relationship I have used the earnings and revenue tool from Stock Traders Daily to understand exactly how influential Apple has been over the IT sector during both the second and third quarters of 2012. This relationship is important when assessing future earnings and revenue growth for the sector.

First, Apple is flirting with clear support near $520, but if this level breaks the stock could fall by another hundred points quickly. The technicals show a broken pattern, the up channels no longer exist, and the risk of material decline is high.

Taking this technical approach is often criticized even though the decisions of smart money, who are the ones that usually know best, can be identified by price movement. If our intention is to determine what will happen in advance we can observe what Smart Money does with their pocketbooks to get an understanding of what they might know about the future. In this particular case there are still a large number of emotional investors in Apple who refuse to believe that Apple may actually have become a completely different company this year.

Importantly, I have said before that I expect a material shift in growth in 2012, we have not yet seen this show up in either earnings or revenue from Apple, but if it does the valuation of the IT sector will be scrutinized extensively. That all starts with an evaluation of Apple's influence in previous quarters.

Starting with the second quarter of 2012 the EPS growth rate for the information technology sector was 6.89%. That compared to a growth rate for all of the stocks reported in the second quarter of 4.13%. Revenue growth for the IT sector was 4.69% and that too looked good against all companies whose revenue growth was 2.39% in the second quarter of 2012. However, when we remove Apple's influence from the IT sector the EPS growth rate for the second quarter drops to 0.53% and the revenue growth rate drops to 1.55%. Without Apple, the growth rate of the IT sector would have been much lower than the growth rate of the market itself.

In the third quarter the IT sector grew EPS at about the same pace as the market, 4.09%. Revenue outpaced the market coming in at 2.82% versus 1.94% for all of the stocks reporting. However, like last time, when we remove Apple the growth rate looks considerably different. EPS growth rates are reduced to 1.39%, considerably below the market average, and revenue actually contracts, declining by 0.46% for the information technology sector overall.

The purpose of this article is to take a look at Apple's influence and engage a discussion about valuation accordingly. I do not know exactly how Apple's earnings and revenue growth rates will change, but I do know that the information technology sector would be lagging the market considerably without Apple, and smart money has already begun to make a decision with their pocketbooks. The question is if Apple's growth rate slows significantly will the information technology sector fall out of favor?

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

Business relationship disclosure: Written By Thomas H. Kee Jr. President and CEO of Stock Traders Daily. Neither Mr. Kee or Stock Traders Daily receives any compensation from the companies mentioned in this article for writing this article.