Apple: As Good As It Gets

If The Motley Fool allowed for subtitles on articles, I'd have tagged this one "Waaah! Why isn't my Apple (Nasdaq: AAPL  ) stock at $1,000?? Everyone said it was a blowout quarter! All the people on CNBC said it was going to $1,500. Waaah!" Yes, I know, that would be a really long subtitle.

Kidding aside, and given how strong the most recent quarter's numbers were, it's fair to wonder why the stock is going down and not up. First the stock drops from $644 all the way down to $555 the day of earnings, and then it climbs up to $618, and then it falls right back to Friday's close of $565. None of it makes sense, right? The stock is so cheap, trading at just 11.5 times next year's earnings, right?

Let me take a crack at explaining.

There are lots of short-term explanations for why Apple's stock is going down:

  • The broader market is falling.
  • It broke its 50-day moving average.
  • It had to fill the gap.
  • It's just profit-taking; people have made a ton of money.
  • The jobs numbers were terrible, but not bad enough for QE3.
  • The law of large numbers will kick in.
  • The company provided a conservative outlook for the June quarter.
  • Apple has some tough comparisons ahead.
  • Sell in May and go away.
  • Europe is in turmoil. Sarkozy lost and the pro-bailout Greeks got tossed.
  • How long will flash and DRAM prices stay down? Margins will get squeezed.
  • Qualcomm's (Nasdaq: QCOM  ) chip supply constraints could negatively affect Apple's ability to roll out its next generation 4G phone.
  • Apple really hasn't innovated since Steve Jobs passed. (Yes, people say this.)
  • Carrier subsidies are going to shrink, hurting margins.
  • Google's (Nasdaq: GOOG  ) Android is a sleeping giant, whose mobile platform is used on more than half of U.S. smartphones and continues to take share worldwide.
  • Microsoft's (Nasdaq: MSFT  ) new Windows 8 release and its enhanced touchscreen functionality could provide some much-needed competition to iOS and Android.

I'm sure that the short-term answer lies somewhere in those 16 excuses. But I don't believe any of them matters in the long-term story of Apple. Unlike other amazing consumer brands such as Coca-Cola or Procter & Gamble, Apple has a volatility problem.

The success of Apple is now, and has always been, based on people's perception that its next-generation products will be significantly better, cooler, and more amazing than its last. It's the biggest blessing and curse of the brand, and part of the marketing mystique that Jobs so successfully created. People don't wonder aloud, "How can Tide detergent ever top Acti-lift?" or "Can Coke Zero go even lower? Maybe negative-calorie Coke?" People don't talk about that. But they do actively wonder how Siri will get better, or why they should buy the next iPad or iPhone.

At every turn, investors and consumers are asking, "Is this as good as it's going to get?"
This isn't a problem unique to Apple. It happens to all hardware manufacturers -- Dell, Sony, Callaway, Kodak, Nintendo, Jeep, and countless others. It's worse with Apple, though, because it has blown us away so many times in the past decade, and the bar is higher.

So, what's the problem? The market is littered with hardware companies that couldn't keep blowing us away, and stock prices that fell hard as a result. Sony is at a 25-year low. Nintendo just reported the largest loss in company history on the heels of a terrible 3DS launch and Wii sales that fell off the face of the earth. Kodak is bankrupt. In short -- and disagree with me if you must -- it's rare to see a hardware businesses become a massive long-term winner. And even the best of them go through periods of massive product cyclicality -- just as Hewlett-Packard has recently and Apple did in its not-too-distant past. (Can you say Newton?)

Of course, the market knows this, which is why nobody is going to give Apple a rich multiple. Can you imagine if the market treated Apple like other growth stocks? Giving it a multiple commensurate with its current growth rate? The stock would be at $4,200! The PEG ratio doesn't apply here, kids! The other shoe is always just a product cycle or two away from dropping.

I know it's inconceivable for us to imagine that Apple will fall back to a second-rate company five years from now, but this has happened so many times to companies on top of the heap, you simply can't disregard the strong possibility. And that's why the stock is trading at just 11.5 times next year's earnings.

Despite my ominous tone, I actually believe Apple can do what no other company has ever done -- for a while, anyway. But it'll need at least one more major hardware offering and a few other key ingredients that might be tougher to work out. Were Tim Cook to call me up and ask for my advice, this is what I would tell him:

  1. You need to introduce Apple TV, now. Home entertainment is still about big-screen TVs, gaming platforms, and sound systems. In the conference call, when asked about convergence, Cook said, "You can converge a toaster and a refrigerator, but those things are probably not going to be pleasing to the user." Right. And I don't want to watch Mad Men on a 10-inch iPad when I have a 60-inch big screen in my living room. With all of the gaming platforms aging, no clear choice in televisions, and Apple with a massive ecosystem of game developers champing at the bit, it's time to introduce the 70-inch iMac with beautiful Retina Display, a built-in gaming console, and a DVD player -- a Wi-Fi-enabled, Ethernet-equipped home-entertainment bonanza.
  2. iCloud. Keep pounding this, because 125 million people love it and it represents the biggest opportunity you have to enhance the switching costs of the ecosystem. I cannot tell you how much I love having all of my stuff on all of my devices. Don't shoot yourself in the foot with pricing on this -- make it cheap.
  3. "The New." It's obvious to me that Apple realizes its conundrum. This is why the most recent iPad offering wasn't iPad 3. It was "the new iPad." It's also why we don't buy Mac 12. I suspect the next iPhone will not be iPhone 5, but "the new iPhone." Apple is aware of the "top it" mentality and is changing its marketing to combat this phenomenon. I think this is smart, and I would advise Cook to keep it up. Reduce expectations while still delivering awesomeness.
  4. Content. This is where the real battle is going to be waged, isn't it? What good are all these razors without the content blades? Netflix, Hulu, iTunes, Amazon.com, Nook, Kindle, Zune (heh), xBox, PlayStation, Wii. Everyone wants content. Everyone is waging war over the content rights. Apple may never win this war, but it at least needs to keep up with the Joneses. It will win by delivering the thin-client razors that everyone wants, and the content blades will be forced to stay with Apple for access to the massive distribution.
  5. Information architecture. Glee is on Tuesday nights at 8 p.m. ET on Fox HD, which is channel 505 for Verizon FiOS in Washington, D.C. Why does this information matter? Because it allows me to find it. It allows me to know how to program my TiVo to record it. Without this incredibly important information, I would not be able to consume my favorite content. Network television and the major carriers (Verizon, Comcast, DirectTV, Time Warner) provide us the information architecture for discovery of our favorite programming, much the same way that American Top 40 used to provide us the information architecture to discover our favorite music. Without it, we are literally lost.

    In an age of streaming content, publishers are starting to explore less expensive, exclusive distribution to places like Hulu, Netflix, and YouTube. Apple has, through iTunes, the ability to shift the paradigm away from the cable/telco monopolies. The content just is; it doesn't care where it lives. All of the power rests in the distribution and information architecture. Apple has a chance to own this. Can't you imagine a network like Showtime deciding to distribute its programming exclusively through iTunes? Access to hundreds of millions of people around the world? Oh, and you can watch all of the exclusive iTunes content on your iPad, iPhone, iPod Touch, Macbook Air, or 70-inch Home EnteriMac theater. Networks? What networks?

The Foolish bottom line
More than anything, Apple has going for it what few companies have ever been able to claim. It may be the most beloved company ever. A lot of that has to do with Steve Jobs. It's unclear what the personality of the brand will be now that he's gone. But we're at a crazy inflexion point, and Apple has the biggest foot in the door. If Apple can execute the strategy well, it'll deliver you the next chapter of Assassin's Creed, future Weeds episodes, the latest Glee covers, 50 Shades of Grey, and possibly that $4,200 stock price you so desperately desire.

Apple is just one of many companies taking aim at "The Next Trillion-Dollar Revolution," and while the dominant smartphone player is anything but a secret for investors at this point, analysts at The Motley Fool have outlined a less-followed company poised to participate in a big way in this limited-time free report.

However, if you are interested in a more in-depth look at what is arguably the world's most innovative company, I encourage you to sign up for our new premium research report on Apple. Not only will this report give you a detailed look at Apple unlike anything we've offered before, but we'll also keep you up to date with company developments for a full year, completely free of charge.

David Forrest owns 2014 call LEAPS in Amazon. The Motley Fool owns shares of Qualcomm, Sony, Amazon.com, Microsoft, Google, Apple, and Coca-Cola and has created a bear call spread position in Sony. Motley Fool newsletter services have recommended buying shares of Procter & Gamble, Apple, Google, Nintendo, Coca-Cola, Amazon.com, Microsoft, and Netflix, creating bull call spread positions in Apple and Microsoft, and writing covered calls on Dell. The Motley Fool has a disclosure policy. The Motley Fool has a disclosure policy. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


Read/Post Comments (7) | Recommend This Article (12)

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 May 07, 2012, at 8:28 PM, tychicum wrote:

    It went down so I could buy more :-)

  • Report this Comment On May 07, 2012, at 9:13 PM, accelerando wrote:

    Let me try to explain why apple's multiple is so cheap. First off apple has way more going for it than its cool hardware. Wonder if Mr. Forrest ever heard of platforms or network effect or the incredible stickiness of apple products.

    But that's all not really the point. The point is Steve Jobs. Very possibly the greatest CEO of all time. Now gone.

    Now imagine that apple was founded in 1998 by Tim Cook. A man so gifted as an entrepreneur that he somehow managed to get a fair percentage of the top hardware, software, marketing and business talent on the planet to work for him, while organizing the company in such a way that no matter how large or successful, everyone still worked 90 hours a week as if it were a startup.

    In quick succession there was the mac, the ipod, the iphone and the ipad. Blue sky ahead all systems go. You know what -- apple would be selling at appx its growth rate for something like 4k/share.

    But that is not the narrative. The real narrative is that Jobs founded the company. Got forced out. Then, just as the company was about to go down the tubes he came back and built the monster that is apple 2012. Then he got sick and is now no longer with us. And no one knows how much that means. And that is why apple is so volatile and why its pe is so low and why its peg is in the toilet. At least that's a better story than any other have ever heard.

  • Report this Comment On May 08, 2012, at 12:24 AM, peto3 wrote:

    For heaven's sake, haven't you heard - The King is dead! Long live the King ...

  • Report this Comment On May 08, 2012, at 1:53 AM, deasystems wrote:

    The author wrote, "The success of Apple is...based on people's perception that its next-generation products will be significantly better, cooler, and more amazing than its last."

    Not really. Apple's success is based on its proven ability to delight its customers before, during, and after the sale. That is the company's primary goal.

    "The market is littered with hardware companies that couldn't keep blowing us away...Sony is at a 25-year low. Nintendo just reported the largest loss in company history...Kodak is bankrupt...Hewlett-Packard."

    Great list...and amusing too--all of them are victims of Apple's market disruption and competitive pressure! How ironic--and stupid--for the market to consider the entity that *caused* the demise of those companies to be thought of as comparable to its victims.

    Apple really is different. You'd think that would be obvious by now...

  • Report this Comment On May 08, 2012, at 4:30 AM, reallypeacedoff wrote:

    Has anyone looked at the AAPL chart lately? Daily, monthly, whichever timeframe you look at, it was so over extended that it needed to come down to Earth at some point. Don't get me wrong, I have made boat loads, both going short/long but there is a thing called gravity, and even Apple (no way!) has to come down sometime. Yes, $1000 a share won't be that long off (within 2 years I'd imagine as long as they keep doing what they are currently doing), but it needs a breather. Theoretically I would love to see it hit the 50 day SMA (~$450) and better still, the 200 day (no brain bounce for longs, but I doubt it will ever see ~$390) but we will see what this market does. Panic can be a funny thing, and great for entry points. Funny how any news from Europe has no effect currently yet 8 months ago it was all we were hearing. I believe with the elections coming in November 2012, and the rise from November 2011 to March 2012, they will pull this market back until around June/July and then it will be a nice steady up going into elections. It would look bad on Obama if the market turned to crap during his campaign... Just saying.

  • Report this Comment On May 08, 2012, at 5:48 PM, StarWitchDoctor wrote:

    i see peacedoff wrote his first post today. The apparent argument is that stock prices gravitate. If so, to what center do they gravitate. If it is to a multiple, the price is then meaningless. Relating stock prices to prior dollar values is not analysis. It is bias. Anchoring Bias in this case.

    I am not saying that the price should be higher. I am simply saying that "gravity" (technical) analysis is a poor substitute for fundamental analysis.

    As i have learned over the years. I used to play that gravity game and it cost me alot of dough. Now i am an investor rather than a gambler.

    Scott

  • Report this Comment On May 17, 2012, at 8:26 PM, reallypeacedoff wrote:

    StarWitch,

    I guess you were not so good on the technical analysis side?

    I only trade stocks with technical analysis in mind and it proves itself day over and over again. You can talk #$@% about it as much as you want but I ask, what information do you think institutions trade on? The news headlines? How far the P/E has compressed? What happened to JPM? Blah blah blah.

    When you say 'fundamental analysis' for the average investor, you mean buying at $644 because Kramer reckons it is a buy, right? I feel sorry for the suckers that see the news headlines '$1001' do the math and think 'sweet, $357 profit, I'm in' only to see their impulse and irrational buy down over $100 already and likely more to come. The news headlines always follow the technicals. In fact whatever they are saying on Fox and NBC, it's best to go the opposite way. Shorted Apple at $621 after all the upgrades came in and covered the day before earnings.

    I'm not saying I buy and then sell daily, but it doesn't hurt to look for a good price rather then jumping in with a blindfold. I'll be buying Apple very soon for the long haul. Especially since every one is saying that Apple can't be stopped going downward.

    I better get back to analyzing the technicals.

    Peace.

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