Apple – Valuation Doesn't Matter – At Least for Now

When something falls this rapidly from grace, it is generally a celebrity, a sports figures or the occasional general. It can also be a company, but rarely a company as large and as important as Apple (AAPL). In late September, it was the greatest company in the history of the world. Now, a future Hewlett Packard in the making. Road kill.

Apple Share Price 2012

Apple’s Valuation

We can all agree from a valuation perspective, Apple is cheap. Spectacularly cheap. A few quick metrics on how cheap:

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Apple Valuation Metric	Value
Trailing P/E	11.9
Trailing P/E ex Cash	9.0
Forward P/E	10.0
Forward P/E ex Cash	7.6
Expected 2013 Sales Growth	23%
Expected 2013 Earnings Growth	19%

Apple P/E Ratio Over the Last 5 Years

However, based on how Apple is performing, there are clearly other factors at work that matter much more than current valuation. Because let’s face it. If Mr. Market thinks your future is bleak, your current valuation gets crushed, Valuation metrics that are impossibly low go lower. Just ask Seagate (STX).

Let’s consider what factors could be playing on the stock beyond valuation. In no particular order:

Apple’s Litany of Woes

• Everyone is selling their winners to lock in gains a lower tax rates (Apple is still up 31% YTD)
• iPhone 5 supply and manufacturing problems
• IPad mini supply
• iPad mini price
• Margins are compressing
• Steve Jobs is dead
• There is no next act for the company
• Sentiment is very negative – just watch CNBC to see how the pundits have turned on Apple
• Top level executives leaving/kicked out
• The company is just too big
• At over $500 per share, it is too expensive for the retail investor

Quite a list. As an aside, it seems odd that there are complaints about both the iPad mini’s price and supply. Seems if the price is a problem, demand would be low and supply wouldn’t be. When sentiment turns, logic often departs. However that is a post for another day.

So which of these factors are the problems in the current price action? Probably all of them, with gain harvesting at lower tax rates the likely number one culprit on the list.

What is Apple’s Real Future

Better than the above. A lot better. With the exception of the sixth item on the list, I expect that these issues will recede in time. Each of these issues is either a temporary storm or will get fixed over time. Let’s revisit the list with a longer term perspective:

The Woe	The Cure
Everyone selling their winners	Ends on December 31st.
iPhone 5 supply and manufacturing problems	Already improving.
IPad mini supply	Already improving.
iPad mini price	Demand appears strong. Note the 7 inch device should add a new class of users – kids.
Margins are compressing	Huge new product ramp just in time for the holiday season. Expect margins to improve as manufacturing efficiencies kick in.
Steve Jobs is dead	Can’t fix that, but Jony Ive is good. Really good.
There is no next act for the company	Unlikely given their R&D budget and aspirations (Apple TV).
Sentiment is very negative	Eventually that gets talked out, burns out and fades out.
Top level executives leaving/kicked out	Jony Ive won the power battle with Scott Forstall – that is a good thing, not a bad thing. I am quite comfortable with Jony Ive responsible for both hardware and software. He is the closest thing to Steve Jobs Apple has. They are in very good hands with him. The retail guy (John Browett) was a bad hire, but at least they acted and fixed the problem and fixed it quickly.
The company is too big	The company is huge, but their potential markets are huger still. Only in tablets do they command a dominant market share. It is reasonable to expect Apple’s growth to slow significantly, but there is no law that says growth needs to stop or reverse based on their size. Their products continue to be in high demand, and I expect that will not change in the foreseeable future.
$500+ per share is too expensive	The new management regime is much more shareholder friendly. I expect a split down the road.

 

Apple Price Ratio Over the Last 5 Years

So What To Do

So now that we have some perspective on Apple’s woes, how do we trade it? If you are a short term investor, I would avoid the stock until these short-term headwinds dissipate. As cheap as the stock is, it could get cheaper still. Coupled with the current volatility, it is a very risky time to enter.

If you own the stock and don’t want to sell for tax reasons, I would not sell here, but rather hold on and do your best to ignore the short-term price action.

If you are thinking of buying AAPL for the long term, now would be a great time to enter. I would do it slowly, start to average in over a period of weeks. Long term, I think the stock is a screaming buy at these levels. And as good as I think this entry point is, there may be even better ones available in the near future. Best to keep some powder dry.

Disclosure: I do not currently own Apple and do not plan to initiate a position in the next 72 hours.