Stock Watch


Apple: The Core of Every Portfolio?

Anne Kates Smith

Even without Steve Jobs, the earnings outlook is terrific for at least two more years, and the stock looks cheap.



Editor's Note: On August 24, 2011, Apple's chief executive Steve Jobs announced his resignation, and chief operating officer Tim Cook took the reins. Jobs will remain with the company as chairman of the board. Following the announcement, Apple's stock experienced a rapid, after-hours sell-off. We're featuring this article again to help you re-evaluate the company's prospects in the wake of Jobs' departure.

Everybody knows at least one Apple nut -- the devotee who proselytizes PC users about the Mac, has already owned four iPhones, or stalks the local electronics store for clues about the launch of the next iPad. Call it the cult of Apple (symbol AAPL).

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The investment world has a parallel: fanatically devoted shareowners who are only too happy to let their winnings ride in a stock that traded for as low as $83 in March 2009 and in nearly two years has more than quadrupled, to $351.88. At that price, Apple is worth $324.2 billion, making it the world’s second-most-valuable company, behind ExxonMobil (all share prices and related data are as of February 7).

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If you possess an iota of contrarian instinct, the unanimity of bullish sentiment has to be a bit unnerving. Just about every brokerage analyst who covers Apple loves the stock. The most recent valentine came on February 8, when Canaccord Genuity analyst Michael Walkley raised his target price on AAPL shares from $432 to $460, after indications of strong sales for the new Verizon version of the iPhone. And analysts remained bullish even after Apple announced in January that Steve Jobs, its visionary CEO and founder, has taken medical leave again. “One thing we like about Tim Cook,” says Standard & Poor's analyst Clyde Montevirgen, referring to the company’s acting chief, “is that he has taken Apple's innovation and turned it into a profitable business model.”

And how. Following a boffo earnings report for the quarter ended December 25, most analysts raised the bar for Apple, bumping up earnings expectations for the company, reiterating “buy” recommendations and raising their price targets. “Apple remains the best technology company on the planet,” wrote Brian Marshall, of Gleacher & Co.

Professional money managers are on board, too. Apple accounts for 9% of the assets of T. Rowe Price Global Technology Fund. “The fact is, there simply is no competitor,” says manager David Eiswert. Indeed, the company is a favorite among a wide variety of mutual funds (which means that you might be a member of the Apple cult without realizing it). Few short sellers, who bet on stocks to decline, are betting against Apple.

Is Apple truly the juggernaut that fans claim it is? Well ... yes. At least for this year and probably next, as products and strategies already in the pipeline play out. First came the iPhone’s February debut on Verizon Wireless (previously, the phone was available only through AT&T). Two important product revisions are due later this year: a second version of the iPad tablet computer and the fifth iteration of the iPhone.

Phenomenal growth. For now, the bullish case is compelling. It starts with Apple’s iconic products and the way they seamlessly integrate all aspects of our digital lives. Despite phenomenal growth in many of its product lines, Apple still has a surprisingly low share of several rapidly expanding markets. Consider the iPhone, sales of which account for 39% of company revenues. For the one-year period that ended December 25, iPhone shipments grew 86%, far outstripping the 60%-to-70% growth in smart-phone sales overall. Yet Apple claims just 16% of the world’s smart-phone market -- about equal to that of Research in Motion (RIMM) and far less than that of Nokia (NOK) -- and just 4% of the broader wireless-phone market.

Apple’s computer sales, including Macs and especially its portable MacBooks, are outpacing market growth rates, yet Apple claims less than 5% of the global personal computer market.

Apple is beginning to face competition in the tablet market, which essentially didn’t exist prior to the introduction of the iPad in April 2010. Apple should still claim half the market this year, delivering 30 million iPads in the fiscal year that ends in September, up from just 7.5 million in fiscal 2010. There was concern that the iPad would harm Apple's computer sales, but so far that doesn't appear to be happening. Instead, the iPad is stealing sales from rivals’ lower-end products. “Apple is winning on both ends,” says S&P's Montevirgen, “cannibalizing competitors’ products but not its own.”

An expanding -- make that exploding -- global reach is a crucial part of Apple’s growth story. In the quarter that ended December 25, revenues in Asia grew by 147% over the same period the previous year; sales from China were up 300%. Asia sales are now 25% of total revenues.

After the matter of Jobs’s health, the biggest elephant in the room is Apple’s enormous cash hoard. At last report, cash and investments stood at nearly $60 billion, or about $64 a share. (Debt? There is none.) Having a huge cache of cash has obvious pluses. But, surprisingly, it has also angered many investors, who consider it a woefully underutilized asset, earning next to nothing. They urge the company to buy back shares, make a strategic acquisition or declare a dividend -- maybe all three.

With Jobs on leave, a major acquisition might not be the likeliest scenario now. But a foray into social networking or cloud computing -- the technology of facilitating Web-based applications accessed from anywhere, on any Internet-capable device -- is a possibility, says Eiswert, the Price fund manager. As is the purchase of a media company to supplement Apple’s content library -- Netflix (NFLX), with a current market value of $11.5 billion, has been a rumored candidate.

A dividend would open up Apple to a new class of yield-seeking investors. Paying about $3.50 a share, or enough to give the stock a 1% yield, would cost Apple a bit more than $3 billion a year -- chump change.

The remarkable trajectory of Apple's stock notwithstanding, analysts trumpet the shares as a bargain. They trade at 15 times average estimated earnings of $22.91 a share for the year that ends September 25. That price-earnings ratio is close to the five-year low of 14 and well below the five-year average of 25. Many analysts adjust for Apple’s plump cash cushion by subtracting cash per share from the share price in figuring the P/E -- in which case Apple trades at just 12 times fiscal 2011 earnings. For context, big tech companies overall sell at 23 times estimated 2011 earnings, and Standard & Poor’s 500-stock index trades at 14 times estimated '11 earnings.

Among the biggest uncertainties surrounding Apple is whether the company will be able to continue to innovate so spectacularly if Jobs does not return to the helm. And continued competition from Google’s Android operating system, which has been gaining traction in both smart phones and tablets, could take a bite out of Apple.

Another risk is the potential for declining profit margins as Apple strives to gain and maintain market share, especially if wireless-service providers begin to pay less for each iPhone activation. Gleacher's Marshall estimates that Apple receives about $450 from AT&T Wireless for the activation of an iPhone and about $300 from its international carriers -- well above what other vendors collect.

For now, we side with the bulls. But no one needs to bet all or nothing on Apple. If you're a new convert, try to buy on dips. If you've owned the stock forever, why not reap some profits -- if for no other reason than to humor your inner contrarian?



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