Apple Broken Down

Apple White iPhone

Let me preface this article by saying, I am a fan of Apple (AAPL) products. I own an iPhone, a MacBook Pro, and an iPad Mini. So, I am a bit biased. However, I will be objective as possible when talking about Apple as an investment. 

Apple has been the subject of heated debates from bears and bulls. Let’s first look at the bullish arguments and then the bearish argument. 

Bullish Argument

  • Apple’s valuation is cheap. At around $500/share, it has a market capitalization of around $475 billion. It has a huge cash cushion of around $120 billion. It trades at around 10 times 2013 earnings estimate. This is cheap for a company that has been growing earnings 70% a year over the last 5 years (Source: Yahoo Finance)
  •  The biggest contributor to income, the iPhone, is still the best smartphone in the market.
  • Apple products command premium price and margins.
  • Apple just had a major upgrade cycle, iPhone 5 and iPad Mini just came out.
  • The smartphone revolution is still in its infancy. According to the Business Insider in September, “There are an estimated 6 billion mobile handsets in the world, and only about 1/5th of them are smartphones.”
  • Apple is still not supported by the biggest telecommunications network in China, China Mobile.
  • Apple is working on the next big thing, Apple TV. This could be next catalyst for income and stock price.
  • Once users are in the Apple ecosystem, they tend to buy more products and apps. According to Fortune magazine, Apple is projected to generate $22 billion in App store revenue by 2016.

Bearish Argument

  • Yes, Apple is cheap based on past earnings growth. However, future earnings growth is questionable. It is hard to grow a company earning $40-$50 billion a year much less maintain it. A lot of the cash is overseas and Apple would have to pay taxes to bring it to United States.
  • It is debatable whether iPhone is still the best smartphone. Samsung is catching up or has caught up. The different between iPhone is much smaller than what it used to be a couple of years back.
  • Although, Apple’s premium price and margins have lasted in the pc industry, the smartphone industry is different. It’s a different OS (Windows vs Android) and different manufacturers. Unless, Apple makes much better smartphones, the margins will not last.
  • Apple just had major upgrade cycles, but the changes were not revolutionary. Apple’s products are not matching their hype anymore. The first quarter should be huge, but what about the rest of the year.
  • There are a lot of people without smartphones. However, most of the are not the high income Apple customers. A lot of these customers are in India and China where customers are a lot more cost conscious and will not pay a premium price for Apple products.
  • China Mobile and Apple have been working on a deal for years. Even if the deal goes through, China Mobile has a lot more leverage than other telecommunications networks and the deal will not be as favorable to Apple as with other partners.
  • First, Apple TV has to come out. Once it does, it has to be a success. Even if it is a success and say the product is worth $100 billion. That will only equate to about 20% of Apple’s current worth.
  • A projection of $22 billion generated by the App Store in 2016 is nothing especially when you consider that Apple makes 30% of that revenue. If you factor in taxes, the net income from the App Store comes out to less than $5 billion. This is nothing for company worth $500 billion.

My Take

I believe that people who are predicting Apple to fall below $300/share are foolish. I also believe that people who are predicting Apple to go above $1000/share are foolish.

I see Apple now as a value stock that will trade around the $500 range. To me it does not make sense to buy Apple because its market capitalization is so big. It would take tremendous growth and innovation to move a company worth $500 billion. I have a hard time seeing how Apple can move much higher unless:

  • They maintain their margins and gain market share in the smartphone market.
  • Apple TV is somehow a $100 billion+ product.

Having said that I don’t think there is a huge downside to the stock. I do not see it dropping below $400/share. The $120 billion cash cushion should increase to over $150 billion by the end of fiscal 2013. This should provide downside protection.

Disclosure: I do not own Apple stock.

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