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Should You Take a Bite Out of Apple (AAPL)?

May 16, 2017, 10:13 am

Despite continuing to notch new intraday highs, the S&P 500 has been a bit sleepy lately as stock performance has been mixed over the last couple of months. The same cannot be said for the NASDAQ, which has chugged along nicely. Since the previous peak of the S&P, the PowerShares QQQ ETF (QQQ) has been a strong performer as investors chase names like Facebook (FB), Alphabet (GOOGL) and Amazon (AMZN). And with interest rates low, valuations have become a secondary issue and can seemingly be pushed even higher.

The real star of the show has been Apple (AAPL), which is up over 25% since management reported fiscal first-quarter earnings in January. This is an incredible move for a company that became the first to reach an $800 billion market capitalization just last week. Companies that big don’t usually run that fast. Many in the financial media are chalking it up to the growth of AAPL’s services (digital content, Apple Care, Apple Pay) businesses. However, I believe the reason for the rally is largely because of an increased confidence that AAPL will be able to maintain margins on its iPhones, which will likely account for 70% of gross profits.

Despite an 8% sales decline in the September 2016 fiscal year in the absence of a new iPhone, the decline in gross margins (43.2% versus 44.6% last year) was relatively minor. Now, with the company realizing higher sales again and the iPhone 8’s impending release, investors have jumped into the stock as they wait for earnings to move meaningfully higher. Expectations are now for an increase to $8.95 a share this year from $8.30 a share last year, and then to a whopping $10.40 a share in fiscal 2018.

But I don’t think it’s quite time yet to take a bite out of Apple. I suspect questions about margin sustainability will come up again as meaningful improvements to the iPhone are harder to come by. And as for the cash balance, you often hear the number $250 billion thrown around. But more conservatively, I think that number is closer to $91 billion – the amount of current assets and investments less all liabilities. This is still worth $17.50 a share, which is over 10% of the current value of AAPL. However, I do not think it is enough to drive the stock significantly higher over the longer term in the event that companies are able to repatriate cash in a tax reform law and pay it out in a special dividend.

I also think we’ll see a little nervousness in the shares once the next iPhone is released, as the product is already expected to be a huge hit. Any disappointment would leave the stock vulnerable. Given this, I am keeping AAPL on my watch list but am not recommending it right now. That said, I believe that CEO Tim Cook is doing the best he can with a mature company, as its results have been more resilient than many had expected. Should the stock drop to a 12X or 13X PE range again, where margin risk is at least being partially discounted in the shares, AAPL could become a good stock for a value investor.

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One comment

  1. Just whaching and wondering about apple. THANKS

    Comment by Ronald. Photo on May 18, 2017 at 12:26 am

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