Is Apple a Bubble?

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Before I begin with my analysis, let me discredit myself somewhat.

In September 2008, I bought Apple (Nasdaq: AAPL  ) shares at around $110 per share. After shares ran up, I was proud of myself for playing contrarian during a financial crisis after shares fell from $200 highs.

A year later, happy with my nifty 60% gain, I sold at $180 per share, fearing overvaluation.

As you know, Apple's rise didn't end at $180. Today, shares trade at $300, leaving my 60% gain dwarfed by the 170% gain that could have been.

That's nice, but is Apple a bubble today?
So I'm biased. I'd love to say my analysis was correct -- that Apple was overvalued at $180 a share, and that Apple at $300 a share is a bubble. It certainly feels like a bubble.

Like Treasuries and gold, Apple has had a tremendous run-up. As recently as 2003, shares traded for less than $10 apiece. In other words, those shares have risen more than 30 times in value.

As you may have read, Apple's market capitalization is now second only to ExxonMobil (NYSE: XOM  ) ... and catching up fast. Think about that. Its market cap is 35% higher than Wal-Mart's (NYSE: WMT  ) .

Add those facts up with the zealousness of the Apple enthusiasts (check out the comments section below) and it's certainly easy to call it a bubble.

But wait...
However, there's just as much evidence saying that Apple is either fairly valued or -- gasp! -- undervalued.

On a trailing basis, Apple's selling for 22 times earnings. Not super cheap, but this multiple drops to 17 on a forward basis. Normally, I'd fear that analysts are being too optimistic, but consider these two points:

  1. Apple has averaged 50% growth a year for the last five years.
  2. Each quarter, Apple sandbags analysts, and then destroys their estimates. Over the last four quarters, Apple beat estimates by 13%, 36%, 77% (helped by an accounting change), and 28%.

And remember that the company's forward P/E ratio of 17 is inflated by Apple's cash hoard. The Mac maker has $45 billion sitting on its balance sheet -- or $50 per share in cash alone. Put a third way, that pile of cash is enough money to buy every share of Nike outright.

When you strip out the cash, Apple is trading for a seemingly too-good-to-be-true 14 times forward earnings.

Is it too good to be true?
That question hinges upon the sustainability and growth of Apple's earnings.

Let's hit sustainability first. At 14 times earnings, Apple needs little further growth to justify its price. That may seem pretty shocking, given Apple's growth-stock reputation.

But in technology, the possibility that a company may come in and make your products obsolete is always lurking. Take a look at Research In Motion (Nasdaq: RIMM  ) . A tech darling only a couple of years ago, its smartphones are now under serious attack from Apple's iPhone and Google's (Nasdaq: GOOG  ) legion of Android phones. It's trading at less than eight times forward earnings, because its base of earnings is suddenly tenuous.

In Apple's case, its computers are probably safe, given its position in a fragmented market; its iPods are being cannibalized by its iPhones; and its iPhones and iPads are still in their big growth phases. A Facebook-replacing-MySpace event could happen to Apple, but in the near term, the earnings upon which Apple's multiples are based are sustainably real.

Now on to growth opportunities
I see three major growth drivers for Apple, split up by product.

Who's going to win the smartphone war, Apple or Google? The closed system or the open system? I predict they'll both win -- at the expense of everyone else. 

At the end of Q1, Nielsen reported that Blackberry had a 35% market share in the U.S., while Microsoft Windows Mobile had a 19% market share. Apple was at 28% and Google's Android was at 9%. By August, Android was up to 19%, while Apple has held steady. (Wait till it gets on the Verizon network!) I believe Apple and Google will establish a Visa-and-MasterCard type of virtual duopoly in the future.

This is important, since smartphone penetration in the U.S. has only reached 23%. Earlier in the year, Nielsen pegged penetration to exceed 50% in 2011. And as a recent convert to an iPhone myself, I can't see many converts ever subsequently going backward to a feature phone.

And these opportunities just cover the United States; the rest of the world remains wide open.

When the iPad was just coming out, I didn't hear many (any?) people predicting its runaway success. Apple has once again made an incredible product that we didn't know we wanted. And its sales are just heating up.

The unexpected
Speaking of folks underestimating Apple, the third growth driver I'm excited about is the unexpected. Perhaps Apple will finally figure out how to make Apple TV a success -- its integration opportunities with the rest of the i-Universe are tantalizing. Or it could reveal another product we didn't know we wanted.

Who knows? I'm not too concerned, because as I said before, Apple's current valuation doesn't depend on a crazy amount of growth. I'm happy to keep this growth driver in the speculative upside category.

The final call
After all this, do I consider Apple a bubble?

There are compelling arguments that gold is a bubble (watch out, owners of SPDR Gold Trust). There are compelling arguments that the bond market is a bubble (watch out, owners of spread-playing mortgage REITs like American Capital Agency). But -- and I'm as surprised as you as I write this -- I don't think Apple is a bubble.

In fact, I'll go further. It's hard to say this after such a run-up, and considering Apple's huge market cap, but if I had to make a buy or sell call, I'd say buy.

I'm going to keep thinking about it for my own portfolio, but if you plan to become an Apple buyer, know that the company reports its earnings on Monday, Oct. 18. Don't be surprised if the iEmpire beats earnings estimates. Again.

We just talked about how Apple is a major player in the smartphone boom, but you can read about a different tech trend to potentially profit from in our free report: "2 Plays for the Coming Tech Boom." Enjoy!

Anand Chokkavelu owns shares of ExxonMobil. Google and Wal-Mart Stores are Motley Fool Inside Value choices. Google is a Motley Fool Rule Breakers recommendation. Apple and Nike are Motley Fool Stock Advisor picks. The Fool owns shares of Apple, ExxonMobil, Google, and Wal-Mart Stores. Try any of our Foolish newsletter services free for 30 days. True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community. The Motley Fool has a disclosure policy.

Read/Post Comments (7) | Recommend This Article (21)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 15, 2010, at 9:13 AM, Reddrummer wrote:

    Bubble is a bit harsh of a term. Are they the best company to buy right now? If you back out cash and short term investments for big softy, its trading at a forward P/E of around 8. A forward P/E of 14 doesn't seem quite as crazy for Apple.

    Also if Apple doesn't in some way return the cash to shareholders (share repurchase, dividends or acquisitions) can you still justify backing it out of the P/E? Because essentially by buying the stock you are forced to hold that much cash (not saying thats good or bad, its just a fact).

    My question here is can they sustain the growth. It would be unprecidented if they do (see the law of deminishing returns). Also, the smartphone industry may be growing, but new phones are entering the market at an alarming rate as well. The Iphone will always be the market leader, but it may not sustain growth at its expected rate. Even still, what if Iphone and Ipad sales canibalize Ipod and computer sales (their cash cow)?

    I'm not saying Apple is a poorly run company, they are constantly not just on the cutting edge of things but defining the cutting edge. However to sustain growth at this size would be unprecidented. Maybe this time is different, but at this stage, i'll watch from the sidelines. That being said, their current valuation definately isn't crazy. So even with all the fanatics, I wouldn't say its a bubble.

  • Report this Comment On October 15, 2010, at 2:23 PM, Caladbolg wrote:

    With Apple profit per item can be more important the sales. According to Fortune, for the first half of 2010 Apple had 3% of smart phone sales worldwide, but took home 39% of the profit. Any wonder why they are sitting on a mountain of cash?

  • Report this Comment On October 15, 2010, at 8:21 PM, MMTInvestor wrote:

    "I'm going to keep thinking about it for my own portfolio, but if you plan to become an Apple buyer, know that the company reports its earnings on Monday, Oct. 18. Don't be surprised if the iEmpire beats earnings estimates. Again."

    Just FYI, AAPL usually runs up BEFORE earnings and then lotsa people dump it afterwards. So, there's a pattern of "buy the rumor, sell the fact" with the share price action that potential new investors should watch out for. I however, will not be one of those new investors :-)


  • Report this Comment On October 17, 2010, at 8:23 PM, TMFBomb wrote:


    Good comment. And as long-term investors, one earnings beat or miss does not an investment thesis make. New investors should definitely pay attention to the earnings announcement to glean more insights, though.


  • Report this Comment On October 22, 2010, at 1:21 PM, RedRockRick wrote:

    The intangible element to Apple's success continues to be Steve Jobs. Without Jobs at the helm, Apple is a bubble.

    You only have to go back to the years when he was not running Apple to see what shape the company was in. He has an uncanny way of understanding what the wants of the public are and how to create a need for his products.

  • Report this Comment On April 24, 2011, at 2:04 PM, Reticon wrote:

    if anything has the potential to pop AAPL it's the recent lawsuits it has started throwing around. Especially against Samsung. Samsung makes a lot of the parts that AAPL uses, so IMO AAPL is either seeing doom and gloom on the horizon and hoping to use Samsung to threaten other competitors, or they are just so desperate in a market becoming dominated by Android that they aren't really thinking at all. They do double dip profits in both mobile and desktop, but double dipping at < 10% market share still doesn't justify the market capitalization. This thing bubbled at $200. Their products are getting very expensive to produce because they are becoming obsolete in < 1 year cycles now. Android, via Samsung, HTC, and LG, are blitzing and Apple knows they are in trouble. Now instead of innovating it's Apple that is imitating. IMO, the upside is exhausted and even that was a result of a propaganda based corporate culture.

  • Report this Comment On April 24, 2011, at 2:07 PM, Reticon wrote:

    btw, I just saw a good article about the propaganda machine that Apple has produced:

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