Why wouldn’t investors treat the Apple stock with respect?

Posted by Shyam Moondra


Recently, when Apple Inc. reported its financial results for the first quarter of 2012, the investors were in total disbelief. Apple’s revenues grew by a whopping 60% and profits almost doubled from last year’s first quarter. And yet, the current Apple stock price is about 7% lower than what it was before the earnings were announced, at a time when the overall market is hovering near the recent 12-month high. How can this anomaly be explained?

Per Yahoo Finance, based on the estimates of 50 analysts that follow Apple, the average 2013 sales revenue is projected to be $195.47 billion (20.4% increase over 2012) and the average EPS is projected to be $53.93 (15% increase over 2012). At the current share price of $603, the trailing PE comes out to be 14.68 (compared with S&P 500 PE of 15.06) and forward PE comes out to be a meager 11.18. Since the financial crisis of 2008 and subsequent severe recession, Apple has consistently produced record profits and yet its PE today is the same as what it was more than ten years ago. So the question is why Apple doesn’t get the respect it deserves.

The investors find Apple’s astronomical revenue and profit growth as surreal, given its huge size. With the current market capitalization of $564 billion, Apple is the most valuable company in the world. Apple has amassed a cash hoard of $110 billion, exceeding the national budgets of some of the industrialized countries. Only a couple of weeks ago, at a share price of $644, the market cap swelled to over $600 billion, a distinction achieved by only two other companies in the history - Microsoft and Cisco (they both have, however, declined in value over the recent years because of dramatic slowdown in their growth rates). If Apple were accorded the same FPE as those of other high-growth technology companies, as the following Table shows, the Apple share price would be in the range of $655 to $4,635.

Company	2013 Revenue Growth	Forward PE	Apple Share Price
Amazon	28.2%	85.93	$4,635
Baidu	41.6%	20.91	$1,128
Priceline.com	21.0%	19.52	$1,053
Ebay	14.5%	15.16	$818
Google	19.0%	12.14	$655
Apple	20.4%	11.18	$603
Microsoft	8.5%	10.52	$567
Cisco	6.0%	10.09	$545

                                                    (Source: Yahoo Finance)

The above Table shows that even though Apple is still growing at twice the rate of those have-beens, Microsoft and Cisco, the market seems to peg the Apple stock as if it were already a has-been. This is in spite of the fact that, in the foreseeable future, most analysts project that Apple’s growth would be around 20% a year, twice the average rate for S&P 500 companies. For the first quarter of 2012, based on the reported decline in the number of iPhones sold by Verizon and AT&T, many analysts feared that Apple would miss the consensus estimates for the quarter. However, iPhone’s initial penetration of the Chinese market more than offset the softer U.S. market, thereby yielding unexpected blowout profits for the quarter. Presently, Apple is in the process of negotiating a deal with China Mobile, the world’s largest mobile telecommunications company, which would open up a huge new market for several years to come.

Apple represents an unparalleled success story in the corporate world. It started out as a small computer company (even today it has only a tiny 5% share of the worldwide computer sales). However, thanks to its genius founder, the late Steve Jobs, it came out with an array of fascinating electronic products that quickly dominated the consumer market. Apple's ingenuity lies in seamless integration of hardware and software to provide enhanced user experience. Its iPod decimated SONY's Walkman music player that was all hardware and lacked iPod's software capabilities that enabled the users to not only store music but also digitally organize the music folders for quick access to any specific song. That success was quickly followed with iPhone with touch screen capabilities that revolutionized the smart phone business, putting Nokia, Research in Motion, and Motorola on the defensive. They also introduced iTunes that totally changed the way recorded music is marketed and sold. Finally, Apple came out with the hugely successful tablet, the iPad, for which consumers would wait in lines running for blocks in major cities around the world. It’s almost as if Apple could do no wrong; their executions of all product development, production, and distribution phases were flawless.

The question now is what could Apple do to make its stock realize its full and fair value, which many analysts believe to be around $1,000 within the next couple of years. The following are the ways to unlock the Apple stock value:

• Keep producing exciting products and impressive profit growths. A new iPhone 5 is rumored to arrive some time this year. An initial iTV could be the next new product which will combine hardware and software to provide tremendous user experience and make the present TVs obsolete. Next year, we could see the new iPad 4 that will keep the sales of immensely popular tablet in high gear for a few years. The iPad market is rapidly expanding beyond the traditional enterprise applications to include military, education, and health care segments. Apple's iMac continues to grow at a faster rate than the overall computer market. Apple is also aggressively working to create an iCloud ecosystem with all of its product lines working together seamlessly. On the recent quarterly conference call, Apple's CFO Peter Oppenheimer said "we have got some fabulous new products in the pipeline." There is every indication that Apple will continue its exceptional growth saga for at least five more years.
• Recently, Apple announced that it will use part of its cash hoard of $110 billion to pay dividends to common share holders and also buyback its own shares in the open market. This amounts to roughly $10 billion a year. Apple has the resources to do better than that; next year they should increase the dividend by at least 10% and make more substantial buybacks (to the order of 10% of the float rather than 1% that they just announced). These actions will give a significant boost to the stock price.
• Apple should consider splitting the stock 10:1. While the stock split doesn't directly increase the value of the investors' holdings, the split does broaden the shareholder base. Besides, it's much easier for the stock to go up from $60 to $90 rather than from $600 to $900. A stock split would also demonstrate the management's confidence in the continuing growth of the company.
• In the next few years, as the company continues to grow, the market cap would also grow to the $1 trillion range. A company of that size would naturally become less efficient and difficult to manage. Apple should start thinking about splitting the company into two or three separate companies (which would lead to higher growth) vs staying as a single company that keeps producing compatible products under the umbrella of a cloud technology ecosystem.

Apple is on a roll and for the foreseeable future it has enough in the pipeline that will keep producing healthy profits for its shareholders. Apple stock is undervalued and as the company announces impressive quarterly results going forward, the stock would have no where but to go up and reach the magic number of $1,000 sooner rather than later. It's conceivable that Apple would be the first company to ever achieve the $1 trillion market cap mark.

Disclosure: The blogger is long on the Apple stock.

The U.S. Supreme Court unlikely to strike down the health care law

Posted by Shyam Moondra

On March 23, 2010, President Barack Obama signed into the law the Affordable Care Act passed by then Democrat controlled Senate and House, which would gradually roll out comprehensive health care reforms by 2014. The most contentious element of the reforms is the individual mandate that requires all citizens, old or young and healthy or sick, to buy health insurance; the failure to do so would automatically trigger a penalty of around $1,000 a year unless exempted because of religious beliefs and financial hardship. Many conservative Americans consider this mandate to be unconstitutional and a power grab by the federal government. The government argues that the penalty is a "tax" which is within the constitutional mandate of the Congress.

The Obama administration's position is that without the individual mandate, the people with pre-existing conditions would either be denied insurance coverage by the insurance companies or the insurance premiums for such people would be prohibitively high. Also, the people would tend to buy health care insurance only when they get sick, thereby increasing the insurance premiums for everybody else. Many without insurance would just go to the hospital emergency room and get treated knowing that the law requires hospitals to treat sick people even if they are not insured and the cost of treating such people would then be borne by the taxpayers.

The individual mandate is not scheduled to go into effect until 2014, but many states controlled by the Republicans chose to seek pre-emptive legal remedy to freeze the so called Obamacare in tracks. Last week, the U.S. Supreme Court (USSC) heard the arguments on two key issues: (i) can the government force the citizens to buy a product or service they don't want to buy and (ii) can the federal government force the burden of the expanded Medicaid entitlement program on to the states without providing full funding.

Since the individual mandate has not been yet implemented, no harm has been caused to the citizens. Therefore, rather than instigate a train wreck, the USSC may choose to not take any action at this time and let the health care reform proceed. After the mandate has been implemented and there is enough data available on the actual experiences of the citizens on the cost-reduction objectives of the health care act, the USSC may then re-visit this issue at a later date after the November presidential elections. Tossing out the health care law now would make it look like a political decision and be perceived as extreme judicial activism which would be harmful to the court's credibility. The government's job is to solve problems and the USSC is part of the government. The USSC's politicized approach to an ideological problem would make them look like an extension of the radicalized Congressional Republicans which can't be good for the country. In any case, if the young people don't buy health care insurance, they will have to pay a lot more when they get old than they would pay if the individual mandate were implemented. There is nothing unconstitutional about the government's attempt to address the problem of high health care cost in the U.S.

The USSC has the following four options:

· Trust the Congress' judgment on fixing a major problem that has enormous implications for our economy and declare that the law is constitutional. Clearly, without the individual mandate, the escalating health care cost cannot be controlled.

· Do nothing. Since the most objectionable element of the health care act, the individual mandate, has not been yet implemented, it's premature to make a decision without knowing how this will turn out. So, in essence, the court could rule to not rule at this time and revisit the issue at some point in the future, after we have had some data on the results from the implementation of the law.

· Let the most of the law stay but declare that the individual mandate is unconstitutional. The Congress would then have to find a fix.

· Strike down the entire health care act including the things that are constitutional. This would seem an overreach by the conservatives on the bench and will do the most harm to the reputation of the USSC.

Given that rapidly increasing health care cost is a major problem, the Congress has the authority to pass laws related to taxes and commerce, and the fact that dismantling the Affordable Care Act would lead to massive disruptions and confusion making the health care problem even more acute than it is now, the USSC would likely opt for one of the first two options as described above.