Does Apple’s Valuation Make Sense?

Does Apple’s Valuation Make Sense?

Apple’s stock price swoon of 25% since September 21, 2012, has been breathtaking. Are expectations catching up to reality, or is it a buying opportunity? I think the latter, and here’s why.

Many are concerned that the current Apple valuation is still larger than any other company in the world. However, unlike Microsoft when they peaked in 1999, Apple today is selling for a 50% discount to the market compared to a 20% premium for Microsoft at their peak. A rationale investor will focus on the underlying fundamentals such as:

1.Huge Underlying Profits: Apple’s profits of $41.7 billion in FY2012 are greater than the $34.4 billion combined profit of Google, Microsoft, Amazon, eBay, Yahoo, Facebook.  Moreover, Apple earns more than twice the combined $19.3 billion profit of HP, Dell, Lenova, Asus, Intel, Acer, IBM, Lenovo and HP.

2. Low PE multiple: Adjusting for current cash, Apple’s market cap is 7.7 times consensus estimates for next year’s earnings; yet the S&P 500 average PE is almost twice that at 14.5.

3. Continued Growth from Strong Product Pipeline: Having recently refreshed the whole product line, Apple has much momentum to continue to grow revenues well above the average for the market. There is still big growth upside, particularly in China.

So why the big sell-off? The primary reason is that the company’s meteoric rise has left most investors with large capital gains, and concerns about rising tax rates coupled with nervousness about the change in tone of press coverage of Apple have left many investors taking money off the table.

Competition concerns are largely overblown. Samsung, Google and others are finally bringing devices to market with features and innovations that move them ahead of Apple. And Samsung’s recent ads making fun of the Apple faithful are brilliant.  But the fact remains that Apple’s integrated ecosystem of Apps, iTunes, iCloud, and Macs make switching costs very high. Microsoft and Windows 8 appear stalled out of the gate and unlikely to be the threat some are anticipating; For example, the Surface is just not selling well, hindered by the lack of an Apps ecosystem and poor channel strategy. Longer-term, Samsung will remain a big threat, as will Googl-rola once Google integrates Motorola into a more seamless experience.

Concern over the lack of breakthroughs is nothing new. Apple has been evolutionary not revolutionary since the initial iPhone and iPad launches, but they’ve consistently made evolutionary changes that keep their overall edge relative to competition yet avoid making it hard for customers to keep up with the changes.  That’s not true of the competition, such as Microsoft’s premature mash-together of mobile and desktop operating systems in Windows 8 that frankly makes it harder for Windows 7 computer customers to migrate to Windows 8 than for those same customers to migrate to OSX Mountain Lion; Apple knows better than to drive customers out the door with change for change sake.

IMHO, the biggest downside is a potential shift away from the large subsidies by the wireless carriers that make up more than half of Apple’s overall profits. That is not imminent, but if wireless carriers choose profitability over market share, that could be bad for Apple. For now, carriers depend on the drug of Apple iPhone sales and continued addiction is preferred to the withdrawal symptoms of losing huge numbers of iPhone customers if carriers unilaterally (or collectively) refuse to pay the subsidies.

More on this and other risks in future posts. But on balance, now is a good time to accumulate shares.