Two Worms Eating at Apple's Core

As someone who joined the chorus of people who thought that Apple (AAPL) would never be the same after Steve Jobs left, it brings me little joy to point out that two worms are already eating away at its core: an Apple innovation drought and the rise of price-sensitive buyers.

So don't be surprised to see Apple's stock begin a steady decline -- interrupted by abrupt plunges when it misses earnings expectations or guides lower.

The deepest problem facing Apple is that it has yet to demonstrate that it can introduce a new category killing product -- such as the iPod, iPhone, and iPad -- since Jobs departed. Sure, Apple defenders believe that Jony Ive, its senior vice president of industrial design, will be able to continue that trend. But he has yet to prove that he can.

In the past, Apple targeted big markets always figuring out how to get in at the right time and do so with a product that took the lead and usually kept it. To be fair, tackling new categories is not something that Apple did every year. But if it has such a next big thing up its sleeve, investors would certainly like to see it soon. 

So what's eating Apple? Here are two of the hungriest worms eating away at its core.

Lack of Social Leadership: Duller Innovation Edge

Sure Apple has had a tradition of acquiring small companies that helped fill in a missing product or technology gap. But during Jobs's last stand, it never thought of acquiring another company to get thought leadership in a critical technology area.

However, rumors that Apple was seeking a stake in Twitter suggest to me that it is giving up on its ability to craft a social network that takes away industry leadership. Even though reports are that Apple and Twitter did not come to terms -- the fact of those negotiations suggests that Apple may be running out of innovation steam.

CEO Tim Cook said that Apple has to get social and discussions of outsourcing that capability make me wonder whether the company has abandoned an in-house approach. After all, Apple's Ping social music sharing network did not take off after Facebook (FB) pulled out of the deal, reports GottaBeMobile.

In the last decade or so, Apple's business strategy has depended on building an ecosystem of providers that created low-priced Apps and content that, in turn, drove consumers to buy its high-margin hardware.

After all with Google (GOOG) selling Motorola-based hardware and Facebook rumored to be considering a hardware strategy, Apple may be getting behind the mobile power curve. This is especially true, as a colleague pointed out, because Siri is a weak product compared to Google's voice product. He points out that if Google can get enough consumers to buy Google because of its Siri competitor, iPhone growth will slow.

And Apple's consideration of outsourcing social to Twitter raises questions about whether Apple's days of innovating its way to success are over.

Missed Earnings: Fewer Consumers Pay Price Premium

Did Apple's missed earnings reflect a deep problem with its new product strategy or just a typical purchasing lull before the introduction of a new product? After all, many blamed Apple's disappointing second quarter results to people not buying the iPhone 4 and waiting for the iPhone 5 to come out.

As hedge fund honcho Eric Jackson told CNBC, “People forget; this happened last October, when earnings were a disappointment. Shares dropped initially, then continued to drop over the next five weeks to about 7 percent below its pre-earnings announcement level.” iPhone 4 sales did tumble 16% "before the iPhone 4 refresh," according to CNBC.

But Jackson expects good things for Apple in the fourth quarter because Siri, the iPhone's female voice-response feature, will speak Mandarin and Cantonese when the iPhone 5 comes out. He told CNBC, “I think Siri is going to be phenomenally successful in Mandarin and Cantonese.”

But there's a deeper problem. The economic slowdown is leading people who do buy Apple products to go down-market. In addition to waiting for the next model, consumers shifted their buying toward cheaper models of iPhones and iPads, according to AP.

The good news for Apple investors is that the stock is under-valued. On a Price/Earnings to Growth (PEG) ratio basis -- where a PEG of 1.0 is fairly valued -- Apple's is 0.7. That's because its P/E is 13.8 and its earnings are forecast to grow 19.7% by 2013.  

And despite missing its latest quarterly earnings target, that 2013 growth rate is a huge slow-down from the 59.2% rate expected when its fiscal year ends in September. So its stock certainly has a margin of safety if it can simply sustain its recent growth rate.

If Jackson is right, now is a great time to buy Apple stock. But if those worms keep eating away at its core, Apple could plunge from the top of the tree.