Friday, April 26, 2013

The Can't Win Decision: What To Do With Apple Stock Here

Apple has been one of the most difficult stocks to analyze in my career.

If you had bought Apple two years ago, in April 2011, you would have enjoyed a gain of around +20%, or about in-line with the S&P 500.  Along the way, however, it has been a much more "interesting" ride.

In the first four months of 2012, Apple soared by nearly +50%, and in the process became the most valuable company in the S&P 500. 

Since then, however, it has retraced most of its gains, falling from a high of $700 in September 2012 to just above $400 today.

The problem for any fundamental analyst over the past couple of years has been that the stock always looked cheap on any number of valuation metrics, particularly relative to its growth rate.

Apple's growth has been ridiculously strong; if the revenue estimates provided by Wall Street are at all accurate, for example, for the period ending September 30, 2013, Apple will have achieved a +45% 5-year revenue compound growth rate, and a +64% 5-year compound growth rate.

Cash flow has been "insanely great"; even with management guidance of slowing revenue growth in the coming quarters, Apple will add an additional $55 billion to its $137 billion cash hoard by the end of the year.

And yet the stock is off -43% in the last 6 months.

Today the stock trades a single digit P/E multiple, and will offer investors a 3% dividend yield under the new plan announced earlier this week.

So what to do with the stock now?  With no near-term catalyst apparently in place, but valuation very attractive, the stock has become the ultimate "can't win" story.

I decided yesterday to reduce holdings in client portfolios.  In some cases, where the positions were relatively small, I have exited the position entirely.  I laid out my rationale to my colleagues in the following memo:

I recommend  selling ½  or all of  Apple.   For now I would suggest  leaving the proceeds in cash.

On a quantitative level, Apple’s announcements earlier this week seems to me to at least be an indication that the foreseeable future for the company will be challenging.  The company’s $50 billion stock buyback is huge, but it is mostly offset by lower guidance.  According to Glen Yeung at Citi, net Apple 2013 EPS will only benefit by about +2.6%, and +5% in 2014 and 2015.  And that assumes that GPM goes higher from here.

As we are all painfully aware, Apple continues to look attractive, with a single digit P/E multiple and a dividend yield that will now be close to 3%. This is what makes the buy/sell decision so hard. Frankly, these are the metrics that prevent us from exiting the position entirely.  However, in some ways you can make the case that the P/E is deceiving – it looks really cheap, but almost 20% of its market cap is cash, which you don’t pay a multiple on. Ex-cash, then, Apple trades at 13x – still cheap, but basically a market multiple.

Personally, I don’t know anything more than I read about its new product cycle. But I wonder whether it will still be able to command a very high price for an upgraded version of what people already have.  For example, if you look at the Verizon website, they are offering the iPhone 4 for free (assuming you sign a two year agreement). If Verizon is indicating that ½ of their Apple “sales” in the first quarter were free phones, what does that say about future pricing?

Finally, the chart looks broken, and I don’t get the sense that anyone here would be a buyer right now.  While I obviously wish I had sold last summer, we can only deal with the situation as it appears today.