Tuesday, April 24, 2012

Apple (cont.)

Today's stock market focus will be on Apple's earnings after the close of trading.  I previously considered the hype surrounding the company and its stock (3/30 blog).  Today I consider the case for investing in the stock or in buying or selling call or put options on the stock.

I don't know what I missed, but  people have been in awe of the company's financial prowess, as it declared its intention to pay a dividend in response to a torrent of cash generated by the company's unique products.  Cash of $30 billion is substantial, but its total stock market capitalization ($524 billion) is one of the highest ever.  So cash as a percent of stock market capitalization is only 5%.  As for the torrent of cash generated, I am unimpressed.  After assuming the payment of a substantial dividend (as I do when looking at any stock), in the last fiscal year the company generated virtually no free cash flow.  In the current fiscal year, I calculate a 7% free cash flow yield (free cash flow divided by the stock market capitalization).  There are many companies with stronger balance sheets and higher free cash flow yields.

On an earnings basis, the stock sells for 12.7 times current fiscal year earnings estimates.  For a company of its quality, that is attractive.  But already 44 analysts rate the stock as a "buy," 9 are "neutral," and only one a "sell."  Earnings estimates for this fiscal year have increased about 30% in recent months, so expectations are quite high.

I would consider selling put options on the stock at lower prices.  If the stock rises, I would keep the proceeds from selling the puts.  If the stock falls sharply and I am forced to buy the stock, I would buy the stock (a great company) at a much lower price than the price today.  That, I think, is the appropriate approach for this company and its stock.

Steve Lehman

Apple:  562

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