Rising Star Buy: Another Byte of Apple

This article is part of our Rising Star Portfolios series.

As we all know, Apple (Nasdaq: AAPL  ) knocked it out of the park when it reported earnings last week. Again. It's almost getting boring at this point.

Earnings of $7.79 per share were ahead of expectations of $5.85, as was revenue: $28.6 billion vs. $25 billion. iPhone unit sales topped 20 million, more than 10% higher than what analysts had predicted and overtaking Nokia (NYSE: NOK  ) in smartphone volume in the process. And iPad supplies were catching up to demand even while Apple sold more than 9 million of the things.

Despite earnings growth of 125% year over year and revenue growth of 82%, the share price has risen by only 5.7% since it announced earnings. And that means the priced-in expectations for growth have barely budged since I purchased a share for my Rising Star portfolio a bit more than a month ago.

Pessimistic views
One reason for the relatively lackluster performance in the share price might be the sheer size of the company. At around $400 per share, it is rivaling the largest company in the S&P 500, Exxon Mobil, in market capitalization. We just haven't been dealing with companies this large for very long, so buyers might be unwilling to bid up the price too far. Yet I believe that in the long run, price follows performance, and Apple's incredible performance will lead to a higher price.

Another reason might be continued concerns over the CEO succession at Apple. With Steve Jobs still on medical leave, shareholders are understandably anxious about who will succeed him. I've written before that Jobs has built a strong team and that members of the board of directors have been taking some action about the succession recently. This is not a long-term concern for me.

A third reason might be uncertainty about where Apple's "next big thing" will come from. A new iPhone later this year probably generates a response more along the lines of "been there, done that" than "holy cow!" And dominance of the cloud is far from sure, with Google, Amazon.com, and Microsoft all vying for dominance beside Apple.

Still, Apple has a knack of introducing products that define their space, as they have with music players, smartphones, and, most recently, tablets, pushing all others aside. Research In Motion's (Nasdaq: RIMM  ) recent decision to lay off a couple of thousand employees seems to be the latest consequence of this dominance. What will be next? I don't know, but given Apple's history, I'd expect it to be well done and well executed.

Optimistic move
At last night's closing price, expectations for free cash flow growth are 11.5% per year for the next five years, 5.8% for the following five years, and then 2.5% from then on, using my usual 15% hurdle rate to discount. This is essentially the same level of expectations as there was a month ago when I first bought. With its most recent results, Apple has proved yet again that it is capable of doing much more, so I view this as a messed-up expectation.

Tomorrow, I'll purchase a second share for the Messed-Up Expectation portfolio, representing a second 2% allocation of funds to Apple.

After you add Apple to My Watchlist, come and discuss the investment on my Messed-Up Expectations discussion board, or follow me on Twitter.

This article is part of our Rising Star Portfolios series, where we give some of our most promising stock analysts cold, hard cash to manage on the Fool's behalf. We'd like you to track our performance and benefit from these real-money, real-time free stock picks. See all of our Rising Star analysts (and their portfolios).

Fool analyst Jim Mueller owns shares of Apple, Amazon.com, and Exxon and has an option position on Microsoft. He's an analyst for the Motley Fool Stock Advisor newsletter service.

The Motley Fool owns shares of Apple, Google, and Microsoft. Motley Fool newsletter services have recommended buying shares of Apple, Microsoft, Amazon, and Google, and creating a bull call spread position in Microsoft and Apple, as well as a diagonal call position in Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool's disclosure policy is never messed up.


Read/Post Comments (2) | Recommend This Article (6)

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  • Report this Comment On July 26, 2011, at 8:53 PM, TheDumbMoney wrote:

    iPad has a LONG way to run, too.

  • Report this Comment On July 27, 2011, at 6:15 AM, pk22901 wrote:

    "A third reason might be uncertainty about where Apple's "next big thing" will come from."

    The NBT1: iPads rule for the next 4 years. (As the iPods ruled mp3 players: above 70%)

    The NBT2: iPhone maintains 30% phone mkt share for the next 4 years.

    If NBT1 and NBT2 are true, Apple will increase net income by 50% for the next 4 years resulting in net income of $150 per share by CY2016. PPS and Market Cap, at minimal multiple of 15x will be over $2250 and $2T respectively.

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