Friday, November 16, 2012

Apple--What Now?

I suggested some weeks back that Apple stock, and the market overall, appeared to be topping out.  Since then, Apple has declined a stunning 26% ($170 billion of market value) and the S & P 500 is down 8%.  I think the market--and the stock--are now oversold.

Apple now sells for approximately 12 times current year earnings, or only 9 times if the company's net cash balance were assumed to be used to repurchase shares (and consequently increase earnings per share and reduce the price/earnings ratio).

There are, however, two aspects of the stock that concern me.  First, the trend of earnings estimates seems to have topped out and begun to decline.  The shape resembles a frown, which for earnings or a stock's price chart, is not a good sign.  (In contrast, a "smile"-shaped curve that can indicate a bottoming out and beginning of an uptrend of earnings or the stock's price chart is a favorable sign.)

Second, despite Apple's enormous commercial success, it does not generate excess (or "free") cash to the extent one might expect.  Based on the latest fiscal year, the free cash flow yield (cash flow after capital spending and dividends divided by the stock market capitalization of the company) after assuming a generous dividend payment was 4%.  That's not bad.  But in the company's latest quarter ended September 30, the free cash flow yield was -2%.  That is a function of two things.  One is the available cash flow and the other is the share price.  I consider a free cash flow yield of 10% or more to be attractive.

So while on a p/e basis, Apple is undervalued especially for such a globally dominant company, and the stock is oversold and likely to rebound, there are troubling signs that warrant monitoring.

Steve Lehman

Apple:  515
S & P 500:  1355

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