AAPL: Hold to mid $600’s. Feb-2013


I thought it would be best to let the dust settle on Apple (AAPL) before attempting to write an article about it. There used to be a lot of hype and hysteria surrounding Apple, on the bullish side. Now it all seems so down and pessimistic. I’ve decided to step in and buy shares below $500 because of its future earnings power, solid dividend, ability to innovate and its deeply undervalued condition. I will use this article to further expand on my reasoning behind being long.

I had previously written an article before earnings came out, to caution investors on the emotional rollercoaster that is typically associated with a company’s earnings report. I suggested that worried investors — are any of them not worried? — wait until the conference call to make a decision on whether to buy or sell Apple.

Well, we all know how the apple fell, literally. The world’s largest company (at the time) took a 10% haircut in the after-hours trading session, finally closing just a few dollars above $460. The next couple of days didn’t offer much relief for shareholders, as Apple traded all the way down to $435. Not many traders, investors or someone with the worst definition for “stock” would have guessed Apple would fall this hard, this fast from the top. But to put this as simply as possible: This is the kind of emotional reaction that creates those once-in-a-decade investing opportunities, for those who can buy when there’s “blood in the street.”

But now what? Many are contemplating the idea of parting ways with their shares. Most investors don’t seem to have any idea on what to do. But this makes sense, they’ve been through a lot and are now hurting. It also depends on what the cost basis is. If your shares where purchased at $50, you may just view this as a bump in the road. If you bought your shares at $600, you’re probably sweating bullets and not very happy at the moment.

I think the best is still to come for Apple. It has completely super-charged the industries it has put its efforts into. Apple hasn’t simply made one or two devices, sat back and waited for a hefty payday. Innovation is at the core of its beliefs, and it keeps working everyday to transform — or create — a different industry. Between the living room upgrade (as highlighted by Seeking Alpha’s Jaded Consumer) and plans to enter the Chinese market with its iPhones (which I’ll go over in greater detail), I am optimistic on Apple returning to the top and this why I stepped in as a buyer last week.

Technically Speaking

Before we get into why this is such a great buying opportunity, let’s take a look at where Apple has been over the previous few years. Below I will show a daily 1-year chart and a weekly 3-year chart. This will show the long-term trend and the slow and steady rise Apple experienced before erupting higher on parabolic buying.

Apple 3-Year Weekly Chart

(click to enlarge)

Source: Stockcharts.com

This shows a very clear representation of Apple’s long-term strength and consistency. You can see that after only a few weeks into 2012, Apple went ballistic, to the upside that is. After a $200 run, an approximate 50% year-to-date return — remember we’re only in April — Apple pulled back slightly before ramping even higher on its way to $705. This move represented a return of over 71% for the year, again from the company with the world’s largest market cap.

Apple 1-Year Daily Chart

(click to enlarge)

Source: Stockcharts.com

This can’t end well — and it didn’t. This is made abundantly clear in the 1-year chart. The top in September is quite obvious, with Apple bumping against the ceiling at $700 for five straight days. Then the collapse slowly followed, with many investors buying on the way down.

First, the 20-day simple moving average (green) broke the 50-day SMA (blue) to the downside. This represented short-term bearish momentum. Then the big one came — and was highly publicized by the media — when the 50-day SMA crossed the 200-day SMA (red) to the downside, which is widely known as a Death Cross to even the most novice chartist. Well, the longer term bearish momentum that is typically associated with a Death Cross didn’t fail to impress, as Apple fell from $560 (the day the cross occurred) to the new low of $435, which was experienced last week and accelerated by what many considered a goodearnings report.

Investor Reaction

It’s important for investors to try and view an Apple investment as emotionless as possible. This came somewhat easily for me, as I didn’t have any skin in the game until the day after earnings (well, I previouslydid, but have been out of Apple for months now). I knew Apple would likely tumble a bit further, but felt the downside risk was now limited. As it currently stands, even if Apple rallied 50% from this point, which is at $457.84 as of Tuesday’s close, it wouldn’t even get back to its 52-week high of $705. With over a $135 billion in cash and continued growth, Apple just simply shouldn’t trade much lower.

If investors can step back, analyze Apple’s fundamentals and apply common sense, they will pull the trigger — the “buy” trigger that is. You have to remember, successful investors and successful traders don’t buy or sell something based on their emotional feelings towards it. They view their entries and exits as systemic reactions to their setups. They might be wrong, but again, the move wasn’t done on emotion. This is no different with Apple.

Fundamental Outlook

What’s the main argument from Apple bears? Although many do not have short positions — and I honestly can’t blame them — the revolving theses I continue to hear is market saturation and slowing growth. But what exactly is slowing growth? Slowing growth could be a company growing at 100% annually for the past five years, and then estimated to only grow 80% next year. While this is both extreme and unlikely, it’s also true. Although the company is still experiencing rapid growth, it is technically slower than the previous years.

This is the same for Apple — sort of. The growth from 2007 to 2010 was huge. For a company the size of Apple to grow the way it did, it’s an amazing feat. But let’s not forget this is a tech company, which can come and go very quickly. Apple will fade, but I don’t think the time is now. While Apple’s growth may be increasing at a slower rate, it’s still growing.

The thing is — and I just can’t seem to stress it enough — Apple might not be growing like it used to, but it is still growing! On the most recent earnings announcement, the big number everyone was watching for was iPhone sales. The round number the Street was looking for was 50 million units sold. Apple came in a little light, at 47,789,000 an increase of 10 million units (+27%) from the same period last year (which was also 1 week longer, for what’s it’s worth). I think Bill Maurer’s article sums it up best, Apple’s Earnings Fall Is Completely Unjustified.

The idea here is that Apple is still continuing to grow. Products still sell, the cash pile continues to swell and demand remains high. I’m optimistic on a future deal with China Mobile (CHL) as well. Although many are unsure of how this will affect Apple, I am confident it will do so in a positive manner. Any time a company that has 660 million mobilesubscribers strikes a deal with a company like Apple for mobile phones, that’s a good thing for shareholders.

So far, the devices appear to be well-received, despite the bears claiming China won’t want such a “high-end” product — at least, this is my experience when discussing it in the comment sections on other articles. Apple sold 2 million iPhones in 3 days last year when it debuted in China. So the argument that Chinese consumers will not want the iPhone appears to be false.

Overall, I feel as though a deal with the world’s largest telecom giant (in terms of subscribers) will propel Apple’s sales to new heights. It will gain exposure to markets that have largely been iPhone-less and this will be a huge catalyst going forward in my mind. How could it not? Perhaps over-exuberance or too much optimism could exist, but I just can’t wrap my head around a bearish argument for a deal with China Mobile.

I also think that Tim Cook is more likely to get a deal worked out than the late Steve Jobs would have. I think Jobs would have gotten much more favorable terms for Apple — if he indeed got a deal completed — but Cook’s not as forceful and intimidating as Jobs. This is both a blessing and a curse. While having a leader like Jobs is great most of the time, arrogance can also weigh down even the best in the business. Not that he was around when it happened, but remember when Apple thought they could do ‘Maps’ better than Google (GOOG)?

Had Apple been trading at a high valuation, I could see such a fall in the stock price. But the fact that Apple’s future P/E ratio is in the single digits — currently at 8.73 — and its trailing twelve month (TTM) P/E ratio is nearly in the single digits, at 10.08, it’s a wonder that this stock continues to linger around these levels.

I also like to examine the PEG ratio. Like the P/E ratio, the PEG ratio sheds light on a company’s valuation, but with respect to the company’s growth as well. A reading of 1 would typically indicate a fair-valued stock. A reading under 1 would indicate a potentially undervalued stock and a reading over 1 would indicate a potentially overvalued stock. Apple trades with a 2-year PEG ratio of .63 and a 5-year PEG ratio of .53, suggesting that the stock is deeply undervalued when considering the future growth.

Note: The 5-year PEG ratio is courtesy of Yahoo! Finance.

Out of curiosity, I wondered when the last time Apple traded this low, valuation wise that is. So I pulled up the charts and used both the 3-year and 5-year time frames. For the valuation, I applied the trailing twelve month P/E ratio. What I found was both non-surprising and reassuring. Here’s a look at both charts with the valuation applied:

3-Year Valuation Chart:

(click to enlarge)

Source: E-Trade

5-Year Valuation Chart:

(click to enlarge)

Source: E-Trade

As you can see on both of the charts above, the TTM P/E ratio hasn’t been this low since late-2011, before Apple began its parabolic run. This is especially evident on the 3-year chart. On the 5-year chart, you can see how the P/E ratio remained at a more elevated state from 2008-10. But in 2011, the P/E ratio began to drop as the stock price remained relatively unchanged (but skewed towards the upside), even as the company raked in enormous profits.

And this is when the valuation “buy” becomes evident. In the tail end of 2011 and even in early 2012, the TTM P/E ratio dropped down to about 10. From there it went on an elevated ride, trading in the mid-teen figures for most of 2012. Finally, in the beginning of 2013, the P/E ratio finally came back down to 10. I would include this as one of my reasons for buying shares right now.

Overall, I think shares are undervalued. This company continues to grow and continues to trade at a discount relative to its future earnings. This is made evident when looking at its P/E and PEG ratios. This is visually confirmed with the two charts above.

Final Thoughts

Apple got where it is today by continually revolutionizing specific markets. The music industry was turned upside down with the introduction of the iPod and iTunes. Honestly, do you even know someone who listens to an MP3 player, that isn’t an iPod? Then the smartphone industry took off with the iPhone, and the tablet market was nothing until the iPad took the world by storm. But with a barrage of competition and market saturation, can Apple be the first to a new, unknown market (again)?

My guess is yes, but whether or not this market/product will be a success has yet to be seen. The way I see it, those who invest now are banking on a huge product from Apple sometime in the future, such as a drastically improved, more influential, Apple TV.

Even if the product takes a while to surface, Apple’s share price will not likely take a huge hit — immediately anyways. The truth is, Apple’s current share price offers a low-risk, high-reward entry point. With enough cash on hand to buy Amazon (AMZN), a 2.3% yield, and estimates of continued growth (for both revenues and EPS) over the next few years, I think Apple’s share price will continue to rise, albeit, perhaps slowly.

Millions of people still use iPhones, iPads and iPods. Until this trend shifts dramatically, I expect Apple to continue selling a boatload of products. The time to be short is over. There’s no measure as to what a new, dazzling product will have or how much a deal with China Mobile will contribute to Apple’s bottom line, but one thing’s for sure: I’m willing to take a bet on it, from a systematic approach. I bought Apple the day after its earnings announcement for $460.68 per share and plan to hold this currently undervalued company until it returns to the mid-$650 range, at the very least. Even without a knockout product, Apple will still continue doing big business with its current products for quite some time


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