An Overbaked Apple

It's hard not to love Apple (Nasdaq: AAPL  ) . If you've ever used a PowerMac or an iPod, you'll know that the company delivers creative products that keep it streaks ahead of the computing industry pack. Its valuation, on the other hand, is another matter. As likeable as the company may be, its price has gotten ahead of itself.

Despite a weak computer market, Apple shares have surged almost 30% in the past three months. Much of that momentum comes thanks to investment lured by the success of the iPod and iTunes. Buzz of a Sony (NYSE: SNE  ) takeover has also fueled excitement.

Sure, sales of the iPod are strong. And it looks like its mini's sales will be strong, too. But prices for music players are likely to tumble now that the competition, ranging from Motley Fool Stock Advisor recommendation Dell (Nasdaq: DELL  ) to Sony, is piling in. Profit margins are low in consumer electronics, especially if resellers such as Hewlett Packard (NYSE: HPQ  ) are taking a share.

But what about Apple's PowerMac? Its hefty gross margins are behind much of Apple's overall profits. Recently, however, PowerMac G5 sales have been disappointing, and we may see similar results in future quarters.

Then there's iTunes. As the leading online music distribution service, iTunes will no doubt drive iPod sales. Remember, though, that iTunes is a strategic asset; as a stand-alone, it contributes little to Apple's bottom line. Besides, iTunes isn't invincible. This summer, Microsoft (Nasdaq: MSFT  ) will launch its own software that will give portable digital music players access to rented tunes, and Wal-Mart's (NYSE: WMT  ) getting into the digital music game, too.

At 37 times 2004 earnings and 30 times 2005, Apple looks pricey. Even if it pulls off a 20% earnings growth over the next three years, that still puts it trading at a generous PEG of 1.6. If iPod runs out of steam, Apple's earnings will most likely decline. Further, the stock trades at a 50% premium to Dell, which itself trades on a rich multiple.

Don't get me wrong. I love Apple, especially when it's hot. But I don't like it overdone.

David Gardner recommended Dell Computer for subscribers of Motley Fool Stock Advisor. You can sign up for the newsletter with a six-month, money-back guarantee here.

Fool contributor Ben McClure hails from the Great White North. He owns no shares of any companies mentioned here.

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