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How High Can Apple Go?
08/17/2012 7:15 am EST
As our look back at the Best of Jubak 2012 continues, here’s a prophetic look at the world’s largest company. The shocking thing is that even after the very accurate run-up Jim predicted here, many analysts still see the stock as bargain-basement cheap.
After Apple (AAPL) blew away earnings estimates on January 25, Wall Street analysts rushed to push up their price targets for the stock. After all, consensus earnings estimates were $10.07 a share for the quarter ending in December, and Apple delivered $13.87 a share in profits.
FBR Capital put in a one-year target of $525. Morgan Stanley said $515. Citigroup went wild and said $600 a share.
The stock, which closed at $446.66 before the company announced earnings, hit $509.46 a share on February 14. It pegged a high of $526.29 the next day. And despite some amazing volatility recently, shares closed at $516.39 on February 23.
Wall Street analysts rushed back to their models. $570 a share, said Oppenheimer. Credit Suisse upped that to $600. Morgan Keegan and Canaccord went to $650. Searching on February 22, I found a price target on SeekingAlpha of $790 a share.
It’s enough to remind you of the heady days just before the dot-com crash in 2000 when analysts raced to see who could get 15 minutes of Internet fame by topping the audaciously higher target price of yesterday with one even more outrageous today. In October 1998, it was Amazon.com (AMZN) to $400. By December 1999, it was Qualcomm (QCOM) to $1,000.
We all know how that worked out. The technology-laden Nasdaq hit its all-time closing high of 5,048.62 on March 10, 2000—and then fell off a cliff. By May 2007, it had clawed halfway back to its 2000 high. On February 23, the index closed at 2,956.98.
Investors who remember the technology crash of the Nasdaq fear that if they buy Apple now, they’re jumping in just before the plunge. And even more frightening, some investors who remember the 2000 crash also think of Apple as company built on fashion. They worry not only about a replay of 2000, but what happens when Apple misses the next fashion trend.
To these investors I’d say, "Hey, it is different this time."
Apple’s stock is cheap right now. You heard me, cheap—because of these very worries. I think $600 a share is a very conservative target price for Apple. I think you have to go out to $650 before you come up with any barriers that might limit the stock—and even then, the barriers are mostly in investors’ heads.
Why Apple Is Cheap Now
Apple sports the biggest market cap of any company in the world—$478 billion. But it trades at just 12.1 times projected fiscal 2012 earnings per share. (Apple’s fiscal year ends in September.) Take away net cash of $100 billion (yes, that’s billion) and the stock is even cheaper.
Sales grew by 66% in fiscal 2011, and Standard & Poor’s forecasts 48% sales growth in fiscal 2012. Gross margins are climbing. Standard & Poor’s forecasts that 2012 gross margins will climb in fiscal 2012 from Apple’s 40% in fiscal 2011.
So this isn’t a stock trading at 100 times revenue and on the distant promise of earnings.Â Here you’ve got a company that has grown earnings per share by 82.7% in fiscal 2011, by 66.9% in fiscal 2010, and by 69.4% in fiscal 2009—and it trades at a trailing 12-month price-to-earnings ratio of 14.6?
The price-to-earnings growth rate ratio for this stock, on the projected five-year earnings growth rate, is just 0.62. (The PEG ratio divides the P/E ratio by the earnings growth rate to give an investor an idea of how cheap or expensive a company’s growth is.)
And you know what the PEG ratios on projected five-year earnings growth are for these stocks? For 3M, it’s 1.38—growth at this stock costs more than twice as much as at Apple. The PEG ratio for American Electric Power is 3.37.
If there’s an expensive stock in this bunch, it’s not Apple, but that solid utility stock.
And to investors I’d say that despite all the hype around Apple, I think it is one of the least-understood stocks in the market. Apple isn’t a gadget company at the whim of fashion.
It has built at least two major competitive advantages, and it keeps investing heavily in each. And it looks like each advantage is just getting stronger. I don’t see anyone out there ready to eat away at them.
Apple’s 2 Major Edges
- First, Apple has built an extraordinary hardware-software ecosystem that yields products that better integrate hardware and software. That gives the company a way to introduce products that are in many ways presold to consumers.
Apple designs and controls the production of its own hardware and software. That control may rankle companies that work with Apple. But it means that the company’s App Store is cleaner and easier to navigate than the Android store, that its products are easier to set up out of the box than the conglomeration that is a Microsoft (MSFT)/Intel (INTC)/Hewlett-Packard (HPQ) PC, and that its products—to an imperfect but still extraordinary degree—work with each other.
To really, really compete on this level, Google (GOOG) would have to not just buy Motorola Mobility (MMI)—for $12.5 billion—but also find a way to finesse its relationships with all the companies that produce their own flavors of Android phones.
Importantly for investors, Apple understands its advantage here, and is building on it. Take the new iCloud product. Are consumers really prepared to differentiate the quality of one cloud-based service from another? Not really—short of a service producing massive outages or data losses.
But they do know how easy it is to access cloud-based storage, upload, and download, and how easy it is to use the service from any of their multiple devices. I can get iCloud with my iPad and iPhone? Sure, I’ll try it. And once the consumer has tried it, every use makes changing a bigger hassle.
Or, take the new operating system for Apple’s Macs, Mountain Lion, due this summer. It won’t try to make the Mac experience just like that on the iPhone or iPad—that would actually be disruptive to loyal Mac users. But it will move the computer and mobile operating systems into closer alignment, so that users of any device will feel that flash of recognition that this too is an Apple environment.
Oh, and industry rumor has it, Mountain Lion will have improved hooks to Apple TV. Anybody really think that Apple TV, in some form, isn’t Apple’s next big product direction?
- Second, Apple is one of the technology industry’s great manufacturers—although it makes almost nothing in factories it owns.
Apple’s integration of hardware and software doesn’t just happen, especially for a company that manufactures so little of what it sells.
One of Apple’s biggest areas of investment each year is its supplier network. The company spends billions to make sure that the companies that make Apple products make them to Apple standards and get them to where they need to go on Apple schedules.
In fiscal 2011, Apple’s capital budget came to $4.4 billion. Of that, about $612 million went into the continued build-out of Apple’s stores. The rest went into a category called manufacturing and engineering—and of that, $3.8 billion went into international investment, most of that in the company’s suppliers.
I think there are two great manufacturing stories in the technology industry today. The first is Intel, which builds its own factories and relentlessly uses manufacturing technology to drive its competitors into irrelevance. The other is Apple. The two models are entirely different, and both work.
Apple’s is so good that last year’s delay in introducing the new iPhone from the summer to the fall stood out as a major Apple lapse. In a technology industry that is filled with product delays, that’s an impressive performance from a globally distributed manufacturing operation.
If you think this is easy, go ask Boeing (BA).
A Peek into the Future
The big question for investors is how long Apple can keep this up. I think that’s a legitimate worry. Where will Apple’s next 80% in earnings growth come from?
We can see partway down the road. It looks like March will bring the iPad 3, with a higher-resolution display. And in September or October, Apple will introduce the iPhone 5 with a bigger four-inch screen (likely), and with Qualcomm’s quad-mode chip to enable the phone on 3G and LTE networks.
The iPad 3 will enable Apple to drive the still-immature tablet market. Before iPad, sales of tablet devices ran at about 200,000 units a year. In fiscal 2010, the first year of availability, Apple sold 7 million iPads. In fiscal 2011, sales came to 32 million iPads. And this is essentially without a significant penetration of any developing economy.
Over time, I’d expect that Apple will lose market share in tablets. But over time, Apple is picking up share in the smartphone market.
Credit Suisse estimates that Apple will grow its share of the smartphone market to a 24% in 2012-2013. That would be a huge increase, since Apple had just 12.4% of global smartphone subscribers at the end of 2011, according to comScore.
Still, it’s not totally outlandish; Apple picked up 2 percentage points of share from the end of September to the end of December. And the LTE-enabled iPhone 5 would (again, industry rumor has it) be compatible with the network operated by China Mobile (CHL), the world’s largest wireless carrier. That should be good for a few points of global market share.
Credit Suisse estimates that there will be 244 million potential customers in developing economies by 2015, with income profiles that would make them potential buyers of iPhones and iPads. These customers represent potential incremental sales of $84 billion for Apple by 2015.
A Last Worry Dispelled
And finally, for worried investors, I’d list one final way that Apple is different from those dot-com companies that crashed in 2000. Apple finished 2011 with $100 billion in cash, and the company is clearly pondering some way to pay some of it to shareholders.
The most likely method, the market consensus now holds, would be through a dividend. If you subtract Apple’s trapped offshore cash and a reasonable reserve for capital investments, Apple still has enough to pay out a dividend yield equal to the 2.1% yield on the S&P 500.
A payout like that would certainly provide major support for the stock—not only because a 2.1% yield is itself attractive these days, but also because paying a dividend would add potential new buyers for Apple’s stock. Institutional investors who are prohibited from buying stocks without dividends would suddenly find themselves able to add Apple to their portfolios.
None of this makes Apple a buy-and-forget stock. If Apple TV is Apple’s next big product, will it be any good? Can the iPhone keep picking up share once Nokia (NOK) stops bleeding smartphone sales?
And there’s an important barrier at $650 or so. Credit Suisse calculates that at that price, Apple would make up 5% of the S&P 500 index.
Very few companies have ever become 5% of the index. ExxonMobil (XOM) and Microsoft (MSFT), yes, but not General Electric (GE) or Wal-Mart (WMT) or Cisco Systems (CSCO). IBM (IBM) managed to reach 6% of the index in the 1980s.
At $650 a share, investors would have to be convinced again that this time it’s different. And maybe at $650 it won’t be.
But $650 is almost 26% from there. Let’s talk again then.
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