Since you, dear readers, recently anointed Apple (Nasdaq: AAPL ) as the best stock for 2010, I don't suppose I'll win the popular vote when calling it the worst. However, here at the Fool there's no consensus opinion, and writers are free to speak their minds. So I'll take a different position from my fellow writers, because the risk/reward ratio here is beyond insane.
One the one hand ...
I have to concede that the go-go attitude of your average Apple fan might be spot-on again. The year 2009 was a victory march to the tune of a 147% return on your investment.
But the key word in the previous paragraph is "might." Let me lay out a smorgasbord of reasons why Apple is way too risky for a guy who happily owns shares of Advanced Micro Devices (NYSE: AMD ) , Hansen Natural (Nasdaq: HANS ) , and Elan (NYSE: ELN ) . That's right -- I'm calling Apple a worse risk-to-reward equation than any of these supposedly super-risky stocks.
And here's why
First up, the fact that Apple's stock appreciated by nearly 150% last year and is cruising at all-time record altitudes could be a classic setup for a fall back to Earth, Icarus-style. Trading at 26 times forward earnings, Apple makes Google (Nasdaq: GOOG ) look cheap. The Big G is worth only 22 times forward earnings, even at a time when a $700 Google share doesn't seem preposterous anymore. Even on Apple fans' preferred measure of cash flow, which helps back out iPhone accounting quirks, Apple trades for a rich 22 times last fiscal year's free cash flow.
We'll get around to a corollary to these lofty valuations in a little bit. Patience, young grasshopper. But many investors have already clocked out, because it looks like they already missed all the gains but certainly could get caught on an express ride back down to less obscene valuations.
And then ...
Some of Apple's core markets do look perfectly safe -- I don't see anybody usurping the supremacy of iTunes in the digital music market anytime soon, for example. And as long as iTunes is the biggest, baddest music marketplace in the world, there will be plenty of demand for the iPod and/or iPhone gadgets that go along with it.
But apart from an enormous moat of public mindshare in that segment, there is very little separating Apple from a deep, dark chasm of commoditization in a vast and growing sea of competitors. The iPhone started a revolution, but others look ready, willing, and able to finish what Steve Jobs started. If Palm (Nasdaq: PALM ) seems desperate and the Research In Motion (Nasdaq: RIMM ) BlackBerry line is getting outdated, you still have to figure that Google's Android platform threatens Apple with a never-ending series of capable smartphones in every variety.
That's bad for Apple, because the iPhone has been held up as the company's saving grace and major hope of serious growth going forward. Sales of iPhones and their accessories in the quarter that ended in September were 185% above the year-ago period according to GAAP sales, though up only 7% in units.
That could be considered pretty respectable, since Apple didn't release a new iPhone in this year's quarter ended in September but released the iPhone 3G in the same period last year. Combined with the third quarter, Apple actually posted a blazing 70% unit growth over the combined period. However, these are also periods when the iPhone probably sat in the best competitive position it will for a long time. When the current year's comparable figures come out, the iPhone will be dealing with a host of new Android competitors that will blanket every major carrier, not to mention seeing Palm roll out across several carriers itself.
The iPhone will need to continue these furious gains in unit terms over the coming years as a slew of nearly free smartphones threatens to push per-phone revenue down and the company mulls ending its exclusivity arrangement with AT&T. That's a move that would result in more sales, but it could also result in a lower subsidy from the carrier, meaning that the iPhone would have to either become more expensive or reduce its margins to keep a similar price point.
Another factor is that the iPhone's rise needs to be taken with a dose of iPod cannibalization. Apple's former breadwinner declined 12% in sales over last year. To help justify Apple's current stock price, the iPhone not only needs to grow at its own prodigious growth rates, it also needs to cushion the blow of declining sales from its quickly fading sister product.
Vote with blood and guts
And that's where the rubber hits the road, melts into viscous goo, and sends your portfolio into the ditches of Wall Street with a sickening thud!
You've heard all about stocks being "priced to perfection," but Apple is way beyond that stage already. It's priced through the fabled Reality Distortion Field, as though Steve Jobs will pull out iPhone-class megahits until the end of time -- meaning that the iSlate will be a killer product, Macs will continue to steal market share, and the iPhone will wade ankle-deep through the blood and hydraulic oil of its many adversaries.
Those assumptions have actually worked out fairly well so far, but 2010 could be the year when the stars stop aligning the way Apple needs 'em aligned. You have the mountainous valuation, the confluence of competitors, and the very real possibility that the next couple of Apple announcements could be Apple TV-esque duds or worse. And Jobs himself has gone through one health scare too many.
If Apple doesn't deliver on its expectations in 2010, we could be looking at a meltdown that would make Massachusetts Democrats blush. Apple is a fine company at heart, and I wouldn't mind picking up a few shares after the wreck, but at today's prices, there's no way I'd buy a ticket to ride this crazy train. Sure, I could be missing some key point and Apple could continue cruising this year, but keep in mind the risk/reward ratio I brought up earlier. There's much that must go right for Apple to keep growing, and I'm not buying into a company that's reaching terminal velocity.
Would you? Vote with your head and not your heart, dear Fool.
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