Is Apple's Earnings Miss a Reason to Worry?

Stock Watch

Is Apple's Earnings Miss a Reason to Worry?

Don't count on Apple falling victim to the cockroach effect.

In investing, the cockroach effect is a theory that holds that substandard earnings reports and other disappointing developments come in bunches, just as cockroaches do. The corollary is that you should sell a stock the first time a company delivers grim tidings because more are sure to follow.

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The cockroach effect may be weighing on shareholders of Apple (symbol (AAPL) following a rare earnings “miss” by the technology giant. Not that results for the July-September quarter were bad. Revenues and earnings jumped 39% and 54%, respectively, from the same period a year earlier. Apple spooked some fans, though, by reporting that it had sold only 17 million iPhones in the quarter -- less than the 20 million that some analysts had expected.

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But Crowell, Weedon analyst James Ragan says this bit of bad news was good news in disguise. The only thing that kept consumers from buying more iPhones in Apple’s fourth fiscal quarter, which ended September 24, was anticipation of Apple’s next big thing. The iPhone 4S, which launched in mid October, registered record sales of four million units in just its first three days on sale. “That’s not hope; that’s real,” says Ragan. “That tells us Apple is going to have a huge December quarter.”


To be sure, shareholders face significant new risks. Although analysts regard Apple’s top executives highly, no one knows how well they’ll do at developing new products without Steve Jobs, the company’s co-founder and guiding influence, who died in October of pancreatic cancer. And, of course, the bigger a company gets, the harder it is to sustain double-digit leaps in sales and profits, which Apple investors have come to expect.

Plus, competitors are nipping away at Apple’s near-monopoly in the tablet market. Apple’s iPad commanded 95.5% of tablet sales a year ago, for example, but just 66.6% in the third quarter. Products that run on Google’s Android operating system have picked up nearly 27% of the market, according to the latest research by Boston-based Strategy Analytics. Microsoft isn’t a competitive threat yet, but it is likely to emerge as a player in the tablet market, too, says Alex Spektor, a Strategy Analytics analyst.

But the tablet market is growing so rapidly that even if Apple continues to lose market share, iPad sales will likely grow 15% annualized over the next four years, says Spektor. And iPad sales could grow even faster if Apple were to offer lower-priced choices -- much as it did with the iPod.

Despite Apple’s stunning growth and its stock’s strong performance, the shares remain remarkably cheap. At the October 25 close of $397.77, they traded at less than 12 times the $34.20 per share that analysts, on average, expect Apple to earn in the fiscal year that ends next September. That is about the same as the overall stock market’s price-earnings ratio, even though Apple is growing much faster than the average U.S. company.


Moreover, as most of you know, Apple is sitting on a ridiculously large war chest of $82 billion in cash and marketable securities. CEO Tim Cook isn’t tipping his hand about how he plans to deploy the cash, but one possibility would be to initiate a dividend, something that Jobs always resisted.

As stock-market aphorisms go, the cockroach effect is a pretty good one. But we’re betting that Apple’s most recent results are not a harbinger of problems to come but a quirk in timing that only underscores the world’s obsession with Apple products. Our advice to investors: Don’t let the latest results bug you.

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