Apple: A Slice of Every Portfolio

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

Everybody knows at least one Apple nut -- the true believer who proselytizes PC users about the wonders of a Mac, who has already had four iPhones, and who stalks the local electronics store for clues about the launch of the next iPad. Call it the cult of Apple (symbol AAPL). The investment world has a parallel: fanatically devoted shareholders who are only too happy to let their winnings ride on a stock that traded for as low as $83 in March 2009 and has more than quadrupled, to $357, in two years. At that price, Apple, based in Cupertino, Cal., is worth $329 billion, making it the world's second-most-valuable company, behind ExxonMobil (all share prices and related data are as of February 11).

If you possess an iota of contrarian instinct, the unanimity of bullish sentiment has to be unnerving. Just about every brokerage analyst who covers Apple loves the stock -- despite news in January that Steve Jobs, Apple's 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's 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. "There simply is no competitor," says manager David Eiswert. Indeed, the company is a favorite of a large number 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.

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 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.

The iPad factor. 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 of 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's not happening. Instead, it's 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%. Asian sales are now 24% 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 advantages. But 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 -- or all three.

With Jobs on leave, a major acquisition may not be likely now. But a foray into social networking or cloud computing -- the technology of facilitating Web-based applications that can be accessed 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 $12.2 billion, has been rumored to be a 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 16 times average estimated earnings of $22.90 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 13 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 concerns surrounding Apple is whether the company can continue to innovate so spectacularly if Jobs does not return to the helm. 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. Plus, there's a 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.

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 periodic price 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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