Apple: Worms Eating the Core or Golden?

by L J Furman, MBA on October 10, 2012

in Apple, Finance, Microsoft, Stock Market

Apple Logo

Apple stock closed on October 9, 2012 at $635. While up $247, or 64%,  for the year, the stock price has dropped 70 points, 10%, from the peak of $705 reached on Sept. 21, 2012. Where will it go next?  What caused this 10% drop? And what about Amazon, Google, Microsoft, & Research in Motion?

Here’s what I think:

  1. Apple (AAPL) will announce earnings on October 25, 2012. I expect $46.79 to $48.9 per share on an annualized basis, up 10 to 15% from the current $42.54 per share.
  2. Apple’s share price will increase back to $700, and then to $750 by year-end, 2012.
  3. Amazon (AMZN), Google (GOOG) and Microsoft (MSFT) will be stable thru to year-end, 2012.
  4. Research In Motion (RIMM) will be acquired by June 2013.

What makes Apple a good investment is

  1. The attention to detail in the design and manufacture of the products
  2. Comprehensive ecosystem, wherein each product drives revenues and sales of other products
  3. Ability to grow and learn from mistakes.
  4. Solid fundamentals – high profits, low debt, low to moderate P/E.

The bottom line is customers buy Apple products, and Apple makes money.

Yet AAPL stock dropped from $705 to $635. This could be due to 5 phenomena:

  1. Apple Maps is simply not good. (Scott Forstall dropped the ball.)
  2. Limited supply of the iPhone 5 – Apple only sold a record 5 Million iPhone 5s the first weekend.
  3. The human resource challenges presented by manufacturing at Foxconn.
  4. Investor sentiment that Apple’s share price of $705 and a market capitalization of $650 billion is too high.
  5. Self-proclaimed “Masters of the Universe” on Wall Street took profits, triggering the price drop.

Before I discuss these, here are the basic financial data on these five companies, current as of Tuesday, Oct. 9, 2012.

Apple & Comptetitors, Basic Financial Data
Symbol Current Price EPS P/E Market Cap Debt to Assets R on Avg Assets
AAPL 635.85 42.54 14.8 590.2 0 27.06
AMZN 250.96 0.82 312.1 115.4 7.67 2.92
GOOG 744.09 33.73 22.43 247.5 5.79 14.93
MSFT 29.28 2 14.73 247 9.85 14.77
RIMM 7.80 -1.17 Undefined 4.16 0 8.75
Table 1. Financial Data from Google Finance, as of close of business, 10/9/12

Re Apple

  1. Apple Maps, today, is simply not very good. CEO Tim Cook issued an apology to Apple’s customers and promised to improve the software quickly (here). This will not effect sales of the phones, but will serve to reinforce in their customer’s minds that Apple, while not infallible, tries. And what other tech exec apologizes to the users for failings in the widgets?
  2. Apple sold 5 million iPhones the first weekend. According to a report on Business Week, here, “Analysts at RBC Capital Markets have cut their forecast for iPhone 5 sales for the December quarter … [to] 49 million units, [from] 57 million.”
  3. The human resource challenges faced by Foxconn are serious. However, while they are problems for Apple, they are not unique to Apple. Acer, Asus, and Lenovo are Chinese brands. Amazon, Dell, HP are American companies. They and other computer, tablet, and smart phone manufacturers also use Foxconn. Apple, Amazon, HP, Dell, and other American based companies started manufacturing in China because the workforce was reliable and inexpensive. It is no longer as reliable or as inexpensive. Eventually Apple, Amazon, Dell, HP, etc. will build their widgets elsewhere. Apple is profitable enough that it can build Macs, iPhones, iPads, etc. here in the USA and make money. It could also find educated reliable workers in elsewhere in the Americas and in Europe.
  4. Investor sentiment that Apple’s share price of $700 and a market capitalization of $650 billion is too high is simply that: sentiment; it is not a decision made on the basis of fact. The stock price is, or should be, a function of earnings, debt, and expected future earnings. Apple’s fundamentals are good. The company has no debt, terrific profits and something like $100 billion of cash. Apple’s probable future earnings are also good.
  5. Self-proclaimed “Masters of the Universe” on Wall Street took profits, triggering the price drop. They will buy back in, causing the price to rise. This is a simple, rational explanation for the price drop.

Apple also has almost no competition. The competitors in the smartphone and tablet space are Amazon (AMZN), Google (GOOG), Microsoft (MSFT), Research in Motion (RIMM), and Samsung. Apple has created an “ecosystem.” It sells the hardware, consisting of iPhones, iPads, iPods, and Mac computers – at a profit, and sells content and applications for the various devices. Everything it sells brings in revenue and triggers sales of other things. It sells via the web, and in “Brick & Mortar” stores all over the world.

Amazon has a family of products in the Kindles, and sells content for the devices. However, at 259 per share, with earnings of $0.82 it’s P/E 313. Amazon’s cloud services may give it increased earnings, but Apple seems to be a safer, more conservative investment. But Amazon lacks Apple’s ecosystem.

Google, which recently acquired Motorola Mobility is the strongest of Apple’s competitors. However, they don’t yet have an “Ecosystem” like Apple’s. Google’s store does not yet drive revenue like iTunes or App store. While Google is begining to sell phones, Google does not (yet) offer a tablet, and offers nothing like Apple development environment. While Google’s future earnings should be good, and their map application is better than Apple’s, Apple’s future earnings will be stronger. As with Amazon, this lack of an ecosystem bringing in revenue is the difference between Apple and Google.

Microsoft competes with Apple in software and is trying to compete in phones and with brick and mortar stores in malls. Microsoft’s fundamental financial ratios are good. It’s P/E is about the same as Apple’s; it’s Return on Average Assets is about the same as Google’s. Where Microsoft falls short is ans always has been vision. This does not seem likely to change. However, Microsoft has the lion’s share of the markets for software that powers workstations and servers. This too, does not seem likely to change. The difference between Apple and Microsoft is Apple’s attention to detail and commitment to elegance, and willingness to admit and then address mistakes.

Research In Motion, the maker of the iconic Blackberry has zero debt, but also has zero profits and is losing market share. While it created a market, it seems to have lost it’s edge. On the other hand, it’s network, patents and customer base may make it valuable to a defense technology company such as Northrup Grumman, Raytheon, United Technologies, etc. The difference between Apple and RIM is Apple can learn from its mistakes and is committed to changing and evolving over time.

Korean based Samsung Electronics Co., Ltd., makes great products, from smart-phones, which run the Android operating system, to televisions. American Depository Receipts, ADRs, are available. The current price is $618 per share. The price ranged from 488 to 625 over the last year, however, I don’t have enough data to evaluate the company. More information is on Samsung’s site, here.

Circling back to Apple, Paul Shea, at ValueWalk, here, put an $800 per share target on Apple. He cited two reports; one by Nomura; the other by Peter Lynch.

“Nomura research… projects that Apple Inc. (NASDAQ:AAPL) will continue to have high growth in the short term, but that growth will level off over the longer term. The company’s growth is projected to remain solidly high throughout 2013. 2014 will see the company face a slowdown.”

“Peter Lynch limits his own arithmetic, stating that he would be willing to pay 20X for a company with more than 20% growth. According to the author, inserting such a a limit leaves the PLFV of Apple Inc (NASDAQ:AAPL) at around $1000. “

Nomura’s forecast suggests that Apple is evolving into a mature company.

Mr. Shea also forecasts introduction of a new product into the Apple ecosystem, which will support Lynch’s analysis and nullify the Nomura analysis. (Note that “PLFV” stands for “Peter Lynch Fair Value.”) My accountant, Jerry, also thinks Apple will soon be valued at $1000 per share.

But there are some challenges. Scott Forstall, Apple’s SVP for iOS development, may be as arrogant and political as portrayed in on Seeking Alpha, here, and MacRumors, here. This may be a personal problem for Mr. Forstall, and a business problem Tim Cook and Apple shareholders, but arrogance and political backstabbing is not unique to Apple.

My expectation is not that Apple will never make mistakes. The people at Apple design great stuff. But they are people. I expect them to make mistakes – and work to address them. Steve Jobs, at MacWorld in ’97, apologized for Apple’s customer service (Youtube / onstartups blog). He promised to fix it and made good on his promise. Mr. Cook, as noted, apologized for Apple’s mistakes with Maps, and promised to fix the application. I trust that Cook will make good on his promise.

Thinking back, Apple, in 2001, offered Macs, iPods, and music via iTunes. As time went on they developed other iPods, the Classic, the Nano, then adding iOS and the “Touch” screen capability that today defines the user experience in cell-phones. In 2007 they introduced the iPhone, and in 2010, the iPad. Throughout the last decade, while keeping the number of products small, they launched new products on their own schedule, and constinuously focused on the details to make incremental improvements to each product. Apple is a $600 billion company that runs like a successful start-up.

As an analyst with Popular Logistics, I am available for research and analysis on a per project or a per diem basis. I can be reached at ‘L Furman 97” @ G Mail . com and US 732 .  580 . 0024.  I am long on Apple.

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