An Undervaluation or a falling knife?
The decline in the price of Apple stock from just shy of $700 in September last year to around $400 currently, has driven heated debate throughout the investment community.
Bears argue that the company has peaked, that the competitive advantage provided by the iPhone has been diluted by the cheaper, similar hardware that is now available. Bulls point out that Apple has a history of repeatedly revolutionising consumer products, and that it is only a matter of time before this, and a concurrent increase in share price, reoccurs.
On the 23rd of July Apple is expected to release its latest quarterly earnings, which are forecast to show a year-over-year decline in earnings for the second quarter running. This will no doubt fuel the aforementioned bears’ argument that the company has had its day, but is this view fundamentally supported, or just reflective of current market sentiment?
First, a look at the downside. While the iPad and other products generate income for Apple, the rise in share price pre-late 2012 was primarily due to the popularity of the iPhone, and its dominance of the smartphone sector. Having lost ground to competitors such as Samsung and LG this year, growth in iPhone sales has fallen, and in turn, YoY earnings. While the latest model, the iPhone 5s, is due to be released later this year it is unlikely to make up the shortfall. This means that as the year goes on earnings are likely to continue to fall (or at best stagnate), which could further damage market sentiment. CEO Tim Cook has reported that a number of “ground-breaking” products are in the pipeline, none however are scheduled for release before 2014. This lack of an upside catalyst coupled with overwhelming downside sentiment might mean that further decline is on the agenda.
And the upside? First of all there is a strong argument that at its current price Apple might be undervalued. Earnings in 2012 were reported at around $40 billion. A market capitalization of around $400 billion values Apple at approximately 10 times earnings, which for the industry could be considered cheap. Lending credence to the undervaluation argument is Apple’s brand value, and ability to hold on to its customers. The smartphone market might have reached a saturation point, but this does not mean that Apple cannot generate revenue from it; a 90% retention rate on customer handset upgrades proves this point. This level of brand loyalty might not correlate with the earnings collapse that would be required to support a valuation much lower than at present. Also, Apple’s track record of revolutionary products cannot be ignored. With watches and televisions reportedly on the agenda Apple could soon be exposed to two more huge markets, and if previous success can be repeated earnings, and in turn share price could increase dramatically.
To conclude, Apple has seen its share price fall consistently over the past 12 months, and as a result has attracted much pessimism from Wall St and investors alike. While this pessimism might yet prove misplaced, for the share price to reverse a fundamental shift is likely to be required. It goes against Apple tradition to reveal what future products might be, but historic acceptance of this tradition by investors was rooted in the success record of Steve Jobs. A clearer sense of new CEO Tim Cook’s vision for the company, and a revealing of Apple’s pipeline, might be needed to boost confidence before many investors are inclined to buy.