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Apple--Why the Shorts are Wrong So Far

|Includes: Apple Inc. (AAPL)
Maybe I’ve watched too much CNBC lately but I think fear that Apple’s share price is going to fall in the near future is overblown. Apple (Nasdaq: AAPL) is Wall Street’s most loved stock this year, with new product launches this year such as the iPad and the new i-Phone OS4 what is not to love? The shorts point to the fact that Apple is now the second largest company by market capitalization in the world and that in and of itself is apparently a good reason to be short--god forbid we analyze any fundamentals. So has a student of Benjamin Graham’s teachings I am going to attempt to value Apple in a short page or so utilizing a fundamental basis (simple earnings calculations and growth rates) and show you why Apple probably won’t be a very good shorting opportunity over the next 6 months or so.
Apple currently has a marketcap around $250 billion dollars, if you back out net current assets (current assets – total liabilities) on the balance sheet the market cap is actually around $230 billion. Apple earned around $10 billion in 2009 (P/E ratio of 23 based on last year’s earnings) and many analysts project earnings of around $13 billion in FY 2010 (trading around 17x forward year earnings—which I would consider a fairly conservative valuation considering projected earnings growth rate of 30% in 2010). To make the valuation even more conservative it now appears Apple will blow past many analyst earnings expectations in 2010 of $13 billion. In case you live under a rock Apple earned $3.33 in Q1 of 2010 against many analyst estimates around $2.20 (that’s a 51% earnings surprise). It now appears Apple is again firing on all cylinders in the second quarter with the new ipad and i-Phone OS4 product launches (of which most sales figures won’t show up until Q3 because it doesn’t ship until June 24). 
Analyst reports I read earlier this year all of which had price targets north of $300 for Apple by the end of the year factored in only between 2 million – 5 million iPad units sold worldwide. Apple has sold 2 million iPads in the first 60 days alone—that’s without distribution to most of the world has the iPad just recently went on sale in many countries. The i-Phone OS4 (which many analysts stayed conservative with on their sales figures) did 600,000 pre-orders the first day available (would have done many more had AT&T’s servers not crashed on the heavy volume). That compares to just 100,000 pre-orders the original I-phone did on its first day (Apple is clearly taking market share). Analysts I’ve been following have been projecting around $2.70 in the 2Q of 2010—I think Apple will again earn north of $3 in the second quarter boosted by stronger than expected iPad and i-Phone sales from the new OS4 as well as the old 3G. 
I project Apple will earn close to $15 billion (yes, a bullish call) this year based again on stronger than expected iPad and i-Phone sales and increasing their market share within their product segments across the globe (the writing is on the wall). I think Apple will trade around $330 by the end of the year based on the information I have available as of now. Assuming Apple still has net current assets (current assets – total liabilities) of $20 billion at the end of the year this would imply Apple would have a market cap of around $310 billion on earnings of $15 billion. Assuming Exxon’s share price stays stagnant this year Apple would overtake Exxon has the biggest market cap in the world and a new round of “shorts” on CNBC would start talking about how Apple shares are poised for fall. 
End of 2010 Valuation
Assumptions:
Stock Price: $330
Earnings: $15 billion or around $15 share    
P/E
20.6
2009 Earnings
$10 billion
2010 Earnings (proj.)
$15 billion
Earnings growth rate
50%
 
Any rational investor will realize 50% earnings growth rate is unsustainable for Apple. I project $15 billion in earnings for 2010 and 20% earnings growth rates for 2011 and 2012 into my FCF valuation model with 10% earnings growth rate in perpetuity post 2012 and a capitalization rate in perpetuity of 6% (which is discount rate – growth rate). Based on these figures I come up with an intrinsic value per share of $406. On a fundamental basis I just don’t see a case for shorting Apple stock at the current moment—the valuation at $270 seems fairly conservative assuming the rest of the year plays out well for Apple which appears highly likely.
Shorts make the most money when their bets are highly contrarian which makes Apple a shorting target since Wall Street has been in love with it most of the year. The problem is that even though many seem bullish on Apple stock its valuation still seems fairly conservative from a fundamental point of view. Add to the fact that Apple appears to have two extremely successful product launches this year (iPad and i-Phone OS4) and Apple’s “huge” market cap is not only justifiable but appears to have more room to run. I think the shorts should sit out on Apple another 6 months—at least until their earnings announcements stop “killing” the street’s estimates. I just want to know where all these shorts were in 2000, they must have made a killing... Either that or they lost their shirt and are now paranoid of everything and are “again” on the wrong side of the trade because “again” they refuse to look at fundamentals.  
           


Disclosure: Long AAPL