Friday, December 14, 2012

Apple Stock--Becoming Ordinary or an Opportunity?

The decision to invest in Apple stock today is not as obvious as it was even a year ago.  The company is one of the most successful in the world, and it recently had the largest stock market value on record.  Great companies are often not great investments, however, because by the time the companies are widely revered their stock prices already have risen amply to reflect that greatness.  Has Apple fallen into that trap of a great company that becomes an ordinary investment?

I noted late in August amid the launch of IPhone5 when Apple set a record for total market capitalization of $625 billion (and a stock price close to $700), that it reminded me of the peak in the technology stock sector in 2000.  As in 2000, at the peak in the share price of Apple stock analysts were scrambling to revise higher their profit and share-price targets.  Price targets of $1,000 or more began popping up, as analysts seemed to want to outdo each other in being the biggest booster of Apple (as they did with Cisco's stock in 2000).

But starting price matters in investing, and despite the current dominance of Apple's business around the world, a starting price of $700 (and a market capitalization of more than $600 billion) for a company whose revenue base had become very large meant that future growth rates of revenues and earnings would inevitably slow in percentage terms due to the huge base.

The stock has since declined 25%, and earnings estimates have become almost ordinary.  The current consensus earnings forecast for the 2013 fiscal year (ending next September) is for earnings growth of 11%.  Have expectations for next year and beyond now become modest enough that the stock at its current starting price of $510 is a good buy?

There are several factors that make this a difficult call.  Though the stock is down nearly 30% since September, it is still up 34% over the past year and 157% over the past five years.  Earnings estimates have begun to trend lower, which is not favorable.  Furthermore, the stock is still very widely held, and if large, momentum-driven fund managers are unloading it because its stock price and earnings momentum have been broken, the selling pressure will be difficult to overcome.

One the other hand, one of the world's great companies now sells at a price/earnings ratio of 10.5 on current earnings, which would be less than 9 times if the company were able to use its net cash on the balance sheet to repurchase stock.  It is in superb financial condition with net cash equal to about 25% of its stock market capitalization, and excess cash flow could be available for dividend increases or share buybacks.

When I was a fund manager, I had little patience for the explanation of "profit taking" when stock prices declined.  I thought it was an excuse when people had no plausible fundamental reason for a decline in stock prices.  But perhaps part of Apple's price decline is indeed due to "profit taking" in anticipation of potentially higher capital gains tax rates next year.  That, plus selling pressure from momentum fund managers--amid recent news stories about greater competitive pressures from Google and others--have probably pushed the stock down to its current $510 price.

If I can invest in a superior company at close to ten times (current year) earnings, I'll typically do it regardless of my hunch about the stock market's overall direction.  Apple is a case where after significant gains in the broad stock market since early summer--and over the past four years--it is still possible to find such a stock.  

Steve Lehman

Apple:  $510

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