With Apple stock reaching record highs this past week, and a stone's throw away from $700 billion in market cap, financial analysts seem to be split over whether this is the ideal time to sell or whether the tech giant still has room to grow throughout the holiday season. So, in lieu of another dry analysis, we've decided to share an email exchange between equities.com's own Senior Editor Joel Anderson, and Quantitiative Analyst Nicholas Bahndari.
So Apple (APPL) crossed $115 today and continues to be on just a wicked tear pretty much all year. It was already the most valuable company in the word on New Year's Day and it's up over 45% since then. At this point, it's only about a 2.5% gain to get to a $700 billion market cap.
Personally, I'm feeling pretty spiffy because I jumped in when it was at about $91 a share after a pullback following the 7:1 stock split in June. I'm up about 27% at this point and we haven't even hit the holiday shopping season. A part of me is thinking I should collect profits now as the stock can only go so high and it's already at ridiculous levels. But another part of me feels pretty strongly that they're about to have another monster Q4 with iPhone 6s and new iPads flying off the shelves for Christmas and January's going to bring another jaw-dropping earnings beat.
So whadaya say? Is Apple finally that perfect stock we've all been waiting for since the dawn of the market? One that will forever rise and rise until we all have yachts and polo teams?
Seven-hundred billion dollars in market cap would make it the largest company in the world by quite a bit with Exxon (XOM) sitting around $400 billion.
So at that point the first question you should ask yourself is, "does this company really warrant the highest overall valuation in the world?” Does it maintain the same kind of infrastructure and have the far reaching power of an Exxon? It certainly maintains similar cash flow, higher margins, and exists in an industry that grows at a significantly faster pace. All these things ring positive for Apple.
What doesn't is the stability of these cash flows. Technology erodes positive margins faster than almost any other industry, and Apple is not immune to this effect. While revenue has grown a little less than $30 billion over the last two years, their net cash flow has actually dropped by $2 billion. This effect will continue to expand as their revenue growth begins to drop.
They are no longer leaders in all tech fields, an effect that led to this explosive growth in stock price, and their products have been commoditized to varying degrees of success. What companies do in this instance is either double down and attempt to maintain their market share (a strategy that usually results in competitors coming in a gradually eroding it) or they begin to spend their cash on R&D, advertising, and the like to increase barriers to entry for competitors.
Looking through their income statements it appears that Apple is taking the latter approach, R&D spending has almost doubled since 2012. While this is a decent sign, it will undoubtedly decrease their margins exponentially over the coming years (which it has already done).
So the P/E ratio that people tout as a sign of legitimate valuation is null and void: it assumes that cash flows will maintain their growth and that the price will either equal or trail the S&P earnings growth. Both of these are unlikely, the first unlikely in the short and long term, and the second unlikely in the short term.
To place another limitation on comparable valuation, people keep comparing the Apple P/E against companies like Microsoft (MSFT) and Google (GOOG) , but Apple is actually considered a consumer goods company. What’s more, when a company becomes that large, its comparables are more accurately compared to other mega cap companies.
When running that comparison Apple is actually 10th out of 21 Mega's, and a quick move towards $700 billion in market cap will leapfrog the next three competitors in P/E, putting it at 6th highest. To warrant the 6th highest (or even 10th highest) P/E in the mega cap zone, Apple earnings growth should be beating most of its competition. Yet Apple has actually seen NEGATIVE earnings growth over the past few years, and shows no signs that it is not at the dreaded 'pivot point' of the earnings curve that all high growth companies eventually hit.
So if Apple doesn't have positive prospects for cash flow moving forward, is already likely overvalued due to street optimism and unrealistic cash flow forecasts, how can it possible warrant a stock move towards a $700 billion market cap, making it the largest company in the world by almost $300 billion?!
Lastly, to address the point you made about the Christmas boost, that particular boost has become quite inconsistent as of late. What happens in the market is that people try to time these events, so the Christmas boost can occur in October if people flood in trying to gain that little bit of extra profit, or in early December if people assume that everyone is going to wait on the boom. It seems likely to me that people have already priced in the boost in Apple's price for the coming future, so I wouldn't recommend it as a buy moving forward.
But shouldn't we be discounting some of the huge pile of cash the company's been sitting on? Sure, the Apple of 2000-2010 that's pumping out products that change the world is a thing of the past, but all the money that company made doesn't seem to have gone anywhere. Should we be thinking of it as a $700 billion company or a $550 billion company with $150 billion in cash?
Certainly, the concerns about the company's shifting position in the broader market are well documented, but it does seem like the board has the resources at its disposal to continue pumping value back to shareholders for some time now. Even if Tim Cook's content with just tweaking the iPhone every couple years and sitting on the current revenue numbers, shouldn't we still be anticipating more share buybacks and an increased dividend over time? And, if that's the plan, doesn't Apple have the sort of stockpile of cash that might actually allow it to make the stock pull a Wile E. Coyote and defy gravity for a while even if it's already cleared the cliff?
Extraordinarily possible, but this actually reminds me a little of a country with solid fundamentals that is preparing for a bit of drop off. Consider the state of Timcookistan.
Now, Timcookistan has generated a significant amount of interest in the form of currency inflows and foreign direct investment. Things are good right now for them Timcookistanis, but there are fears that the economy may have overheated. The Timcookistani central bank doesn't fret too much though, because they believe with the mass of currency reserves they built up during good times they could protect their currency from devaluing too much, and thus create a bit of a 'soft landing'.
Apple can relate to the plight of the Timcookistani people, and does certainly have the cash reserves to create a similar situation. But the important thing to note is that cash supported stock (through buybacks and an increased dividend) does not necessarily completely shield it from a correction. The more cash that is spent to support the stock, the more stable the stock will ultimately become, which is a severe limitation on capital appreciation.
For an example of something similar you can look at the stock action on Microsoft from 2000 until about a few years ago. It fundamentally changes the kinds of investors who are going to buy the stock, and the current investors who are driving Apple further and further upwards aren't those kinds of investors.
Even if Apple unloads $50 billion more in buybacks, all it is turning itself into is a more established mega cap, one that can't continue to innovate and provide the kind of cash flow growth that a valuation of $700 billion would require. It is important to note that Apple, even under very generous valuation assumptions, is not a $700 billion company today without significant future growth. If they begin to unload their cash pile back to investors, they are ceding some of that future growth, and thus making it even more unlikely that the $700 billion valuation is warranted.
I do think they could cushion the blow with their cash, maybe even to the point that the rest of the market just 'catches up' to Apple while they stay static, but a correction of some sort is inevitable in my opinion.
Ah, but aren't we starting to veer into "greater fool" territory here? You may be right that a lot of the people owning the stock now are doing it because the perception is still one of a hot tech company, but provided that the stock keeps going up, are any of them going to sell? On some level, the only thing needed to justify a valuation is someone willing to pay that much for the stock.
So, if the perception created by that cash pile and strong sales persists, couldn't the stock just keep rising. Or, more to the point, just how long do you think Apple can keep it all going with smoke and mirrors? At what point does all that R&D investment need to produce a home run (or at least a double) to prevent the sort of heavy correction the stock saw in late 2012/early 2013? I only ask because, you know, preferably I'd like to dump my stock about 12 seconds before that moment so there's a real timing issue at play here.
Timcookistan is, by the way, utterly gorgeous this time of year. The lemon trees are in bloom and the fresh mutton is to die for.
That provides sort of the question of the century for stocks, how do we time these things? Keynes famously said, I'm paraphrasing, that markets can stay irrational longer than we can stay solvent. Reverse that phrase and temper it, and you have a situation relating to Apple. It honestly could continue for quite a while, and during a correction it is certainly not going to wipe people off the planet. But the longer it goes on for the more severe the correction.
You saw something similar when Apple hit $700 a share and then tanked to below $500. Apple has created a bit of an asymmetrical risk situation, where it is consistent on the upside and volatile on the downside. I think honestly it can continue as long as the market stays bullish.
Editors Note: Contributions by Nicholas Bahndari and Daniel Banas
DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer