Tuesday, November 27, 2012

Apple Shares (APPL: NASDAQ: $586) Attractively Priced at Current Levels

Since early October, Apple Inc.'s (APPL) retrenchment from $705 per share to a current $586 has shaken the faith of many enthusiasts, and in some cases, shaken the enthusiasm for many participants for the market as a whole.

We think the shares are very attractive at current levels. We think the shares offer substantial upside without unrealistic projections of future growth. No doubt, the level of enthusiasm for the shares cooled for good reasons. To name three-- first, the prospect of higher capital gains tax rates provoked investor selling among those with substantial built in gains; two, Apple's "miss" in its latest quarter caused concern among investors accustomed to "beats"; and , three, weaker demand Europe and Asia for Apple products could lead to softer growth.

Based on current consensus estimates, we believe Apple is trading at the low end of its historic range. As you can see from the chart below, Apple P/E ratio on current earnings has declined asymptotically to about 11.6 times.

At current prices the shares are trading below their mid point p/e for the last two years. They are also trading below the SP 500 market multiple.

If the shares were to trade at the midpoint of both historic multiples 14.2 times (17.10 median) and median consensus estimates $49.75 upcoming year and and $57.95 for the following, then the shares should trade at between $800 and $850, and offer a +40% return, even before the current $2.65 dividend. So yes the shares look cheap.

What the multiple decline also suggests is that investors are assuming is a tremendous slow down in growth for revenues, contraction of margins and flat cash flow production: one which the earnings miss would seem to bear out. We have two thoughts. First, the shares have become such a large component of the Index (both price indices and market capitalization) that it is going to be difficult to establish much of a premium to the market because Apple has become the market. Secondly, it would be next to impossible to sustain the company's historic 5 year sales growth rate of 33.08% over the next five years. Of course it is ridiculous to projected growth of 33% going forward for Apple, isn't it? Yes, probably, but growth has y-o-y has seemed accelerate over the past five years. If it could, and it could also sustain its 40% gross margin and 30% operating margin then the shares are hugely undervalued.

Apple Year On Year Growth

2012 v 2011 44.58% 2011 v 2010 65.96% 2010 v 2009 52.02% 2009 v 2008 14.44%

Do we think Apple still has opportunities for growth? We are not technology experts. But yes it does clearly; the iPhone 5 is still a growth product; the company has shortened delievery delays sharply; and the product has yet to be introduced in many markets in Asia. Despite a toughening competitive landscape from many quarters in both the smart phone and table space (Samsung, Google, Motorola and possibly, Microsoft and RIM) Other Apple hardware products are still dominant and in early take-up in many markets. New Media products from the iTunes, music, movies, books, podcasts and apps. are still disrupting legacy media markets. Brand strength through strong design, reliability and m(mostly) virus free software continues to attract buyers while cash balances continue to build. (When these cash balances--now $30 per share net--a substantial amount of which is held by foreign subsidiaries, will be repatriated is going to be determined by upcoming changes in tax law and rates.) Under any tax regime Apple is building cash rapidly.

Apple shares are trading at under ten times projected year ahead earnings. If Apple share were to trade at their median PE ratio next year, the shares would have substantial upside.

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