Since Apple’s earnings announcement, analysts’ reports read like obituaries. They have piled on hard and fast to drop estimates, slash price targets and call the death of Apple’s Innovation. Jim Cramer migrated Apple from the Growth category to the Value category of investing. In just two months, Apple has fallen from investor admiration to investor admonition. Does such swift and extreme shift create an opportunity to invest? Or is it a value trap?
Many are quick to include Apple with the “Has Beens” of Technology. Dell, HP, Nokia and Research in Motion all reigned supreme in their product categories for long periods of time, and fell from grace hard because they did not notice or react quickly to the disruptions in technology around them. Today, Dell and Research in Motion receive periodic boosts for being potential acquisition candidates; HP is still searching for bottom and Nokia may be on the uptick after a spectacular Lumia introduction. Dell’s earnings are expected to continue to decline; HP and Research in Motion are expected to do worse this year than last and Nokia is crawling back from $4.26 earnings last year to an estimated $0.05 in 2013.
Apple, on the other hand, is and has been the technology disrupter with entirely new product categories. Understandably, it would be difficult to create a new category each year yet Apple did update all product lines in 2012.
Apple is projected to deliver earnings growth, albeit at a slower rate, and do so consistently. These other companies, with the exception of Nokia who appears to have turned the corner, are still struggling with inconsistent and negative earnings projections. And when turning to valuation, the metrics are difficult to compare to Apple because of their negative trends or projected earnings losses. Still, on a PEG (excluding cash), Apple trades at 0.4x FY2014 earnings, a discount to HP, and the others’ PEGs are not meaningful. Value investors typically look for anything under a PEG of 1.0 as attractive. When thinking about products, companies, brands and product introductions into this new year, one rarely puts Apple and HP in the same sentence. Why should they be valued the same? Or Apple at a discount to HP?
But people do put Apple, Google, Amazon and Facebook in the same sentence or article when talking about products, companies, brands and product introductions. Of the three, Google has consistently projected upward earnings, and investors have a long history with Google, as they do with Apple. Amazon offers inconsistent earnings and a valuation that baffles most investors. Facebook does show consistently upward trending earnings projections, although it has faced scrutiny of the quality of those projections with the uncertainty in mobile. Yet valuations of these stocks dwarf Apple’s. For FY 2014, Amazon trades at 148x earnings, Facebook trades at 48x earnings and Google trades at 12x earnings. Apple trades at 6x.
If Apple has lost its momentum, where should it trade? Apple is projected to have half the growth rate of Facebook, and 80% of the growth of Google. If Apple traded on par with an 80% growth of Google, or a 20% discount, it would offer investors 38% upside. Even if Apple traded at a 40% discount to Google, it would offer investors a 12% upside from its current price, which is a decent return over a year.
Does Apple deserve to trade at a 40% discount to Google? The underlying fear in Apple stems from iPhone’s fourth quarter market share. The iPhone is the greatest contributor to Apple’s profitability. Deterioration of the iPhone market share signaled to some that Apple would become irrelevant in smartphones and lose margins to many. That is the bear case.
But the match may not be over, and Apple's "fate" may not be a foregone conclusion. Apple has boasted the highest margins in the smartphone industry. It has a deep war chest to buy market share, if it choses. If market share is at the lower end of the market, and Apple can fight a land grab with Google by lowering prices or margins, and perhaps this is the new strategy Apple must undertake. What Apple gives up in profit margins, it may compensate with profit levels. And iPhones are not the only profit center for Apple. Consider iCloud services, iTunes, and software sales that add to Apple’s stickiness and profitability. Yes, Apple is moving into a new era because, after great success with the iPod and iPhone, competitors took notice and started replicating Apple’s products and borrowing the highlights of Apple’s strategy. But a new era does not mean that Apple is over. The markets in which Apple created and competes are competitive. Yet to date, Apple has remained very profitable in those markets which affords it the ability to compete on many levels: price, brand, R&D, product introduction and for talented employees. It has been just one quarter that Apple disappointed on sentiment. It may be too soon to write off Apple as a Has Been.
Apple had previously been a long-term investment because its future seemed very certain and competition had not really become an issue. In terms of the competitive landscape, Apple deserves to trade more in line with the innovators than the previous group. Recall, Facebook, Amazon and Google have all reported quarters that left investors wondering if they were on the right track. Investors who looked at the talent, potential and longer-term opportunity did very well well. Likewise, Apple is attractive at these levels because it is undervalued for where it sits in the industry and the options it has to address the competition on every front. Apple is not a Has Been and should not trade like one.
