Monday, August 1, 2011

Is Apple Actually Undervalued?

Comment from "Dave" on my "Selling Apple" entry last week:
Other than the share price, I don't understand under what rubric Apple is more expensive than it was last year or five years ago. Its relative PE is lower now than it has been at any time since 1998. It's PE ratio is well below its growth rate, a trait more characteristic of a value stock than a growth stock.
This was a timely comment, as I was about to discuss the following brief statement from Daring Fireball's John Gruber, responding to a piece by Matt Richman about Apple's price/earnings ratio:
"If a company’s P/E ratio is supposed to be indicative of its growth prospects, then why is Netflix’s P/E ratio more than 4.5 times higher than Apple’s when Apple is growing its bottom line more than twice as fast as Netflix is?"

I think it’s psychological. Wall Street, collectively, can’t wrap its head around just how big Apple has gotten and how fast it continues to grow. Ten years ago Apple traded at $10 a share; five years ago $65. That’s the Apple Wall Street remembers, and thus today’s Apple at $400 seems like it’s had a really nice run to reflect its last five years of success. The stock is weighed down by old impressions of Apple as a smaller company with niche appeal.
Gruber really nails the reasoning - and changed my mind a bit. However, price/earnings isn't everything. The market may in fact undervalue Apple at $400, but current investor psychology creates the same stock price ceiling that would result from an overinflated PE ratio.

Apple may eventually rise well above $400, but as I said, investors are (right or wrong) mega-skittish at this level. That's the reason the price keeps cycling between $325 and $375; dabs of moderately bad news spur sell-offs whenever the stock approaches that ceiling.

I'm as bullish about Apple's prospects as anyone, but I realize that it's only a matter of time before some serious bad news hits. When it does, I expect a serious sell-off down to the $200s (like last summer). And that's where I'll buy. Will I sell at $400 again? Not sure. I'll see how things feel.


joshi said...

one of the reason apple trades the way it does is that it is widely owned by the fast money set, which is notoriously manic-depressive.

and nobody can really believe that apple will keep doubling its net (it mathematically must run into a brick wall at some time) over the short term. whats the new new thing? will apple have it? and check out nokia - apples gain has been its loss.

i guess the point is that an absolute dollar value on a stock doesn't make sense for a fast grower, unlike a utility.

Jim Leff said...

Good points, Joshi. That was stuff I felt intuitively, and it's great to see it explained clearly.

Numerics like P/E only begin to set the scene. The real mover of markets is emotion (e.g. "$400 SEEMS high, and that makes us nervous"), not reason. That's a presents wonderful opportunities for yogi investors, who can observe emotion without being blinded by it.

Dave said...

I'm still not comprehending your stance, Jim, unless you are just saying that you sold on a feeling. Are you arguing that people are irrationally pessimistic about Apple's prospects (some sort of mythical $400 ceiling) so you are selling? Or do you contend that it is fundamentally overvalued?

I couldn't disagree more with Joshi. The market knows that Apple's growth rate won't continue, and in fact 2012 estimates are quite conservative by AAPL standards. If the market believed that Apple was going to keep growing at the same rate, it would have a much higher-PE.

I'm very much of a fundamentalist and don't believe that most technicians have proven their mettle (what fortunes have been built by technicians?).

I remember when many people argued that there was a $10,000 ceiling on Berkshire-Hathaway's stock. It's now selling for over $110,000. More than 70% of Apple stock is owned by institutions. Individual money-managers can be affected by emotions, just as amateurs can, but I'd be shocked if any of them are the slightest bit worried about any dollar amount.

I totally agree that PE is only one metric to evaluate stocks, but when dealing with non-cyclical companies that have been consistently profitable, it is one way of seeing how the market perceives a company's prospects. There is no reason that I can perceive that Apple should have the same valuation as Kraft.

But here's my main point. If you think the market is pessimistic about Apple, that is MORE of a reason to buy than to sell. I'm an investor, not a trader, and found much more success buying things when they are undervalued than overvalued, when unloved than loved. I never considered buying Apple until last year, when its valuation was at its lowest point ever. It isn't as cheap now, but it's still a good value, IMO.

joshi said...


"and nobody can really believe that apple will keep doubling its net (it mathematically must run into a brick wall at some time) over the short term."

sounds like you agree, not disagree. and in any case, i wouldn't be so quick to pooh pooh the technicians: jim simons of renaissance technologies has one of the best track records around and is right up there will the other billionaires.

most people can't understand the mathematics, which is why he remains relatively under the radar.

Dave said...

Joshi, I do agree that no one expects Apple's growth rate to continue as it has the past few years. It is unsustainable. But I do disagree that Apple is a more expensive stock than it has been in the past few years.

We're talking about a stock whose return on equity and net profit margin is higher than it's ever been. A company with zero long-term debt. A company with a cash hoard as big as the total capitalization of many major corporations (and of course, that cash should be stripped from the price of the share when estimating its worth).

I bought Apple last year (and some more early this year) because I thought it was cheap. I virtually never buy a stock with a relative PE higher than the market average, and Apple did not.

In more than 30 years of investing, this is the only "hot" stock I've ever bought, and the only reason I did is because it shares so many characteristics of the non-hot stocks I usually buy -- good value.

I also bought some Microsoft last year, a mediocre company that is also way too cheap, and for once, my timing is good. Instead of buying great companies at an OK price, I buy mostly OK companies at a cheap price.

Jim Leff said...

Dave, ceiling is as ceiling does. Look at the one year chart for AAPL and you'll see that the market reeeeally doesn't want to value them over $400.

We can argue the arbitrariness of a given price. But while I'm coming away from my notion that it's overvalued (thanks in large part to John Gruber's fine points at Daring Fireball), I'll stick with my conviction that the market THINKS it's overvalued - or, perhaps more accurately, fully valued.

So it's not going to go up much just cuz iOs devices sell smashingly. It's not going to go up much cuz Macs gain market share. It's not going to go up much if a promising new product comes out. Because all those things have happened, and it's stayed in this range. And all those things are what brought it here. But when the slightest negative appears, it will always shoot down $40 or $50 and need to build back up. That's a sign of skittish investors who feel they're near ceiling.

A year or two from now, Apple may dominate an entire new sector. Or have some other game-changing feat going on. And therefore may rise above $400. But, short to mid term, it's more likely that some misstep will elicit more skittish selling. That's just how it's going, regardless of how anyone's analysis says it SHOULD go (if we're going to talk in "shoulds", then why should SIGA trade at $6.70, making the entire company worth less than their signed contract?).

If there's a big sell-off, I'll re-buy. Maybe enjoy $500 if any of the above comes to pass. I wouldn't count on it soon, though.

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