Apple: Falling Knife or Rubber Ball?

It is rare for a stock's every move to be as closely followed as what we see happening with Apple (NASDAQ: AAPL  ) shares over the last several days (and really, weeks). As we tick ever closer to the earnings release next week, opinions over the longer-term prospects of the company are equally fiercely divided. One school of thought thinks that the stock has the possibility to fall much lower, while others, myself included, believe that the stock is ready to buy.

The bear case
There is a trading expression that warns "never try to catch a falling knife," meaning that when a stock is really falling, trying to catch it at the bottom is a good way to get cut. The bears believe that Apple stock is just such a falling knife. These arguments are circulating, even against the backdrop of a greater-than-4% surge in the stock's price the day after its first close below $500 in about a year.

Central to the argument about Apple's downside is the idea that the stock was "over-owned." Apple was a top 10 holding of 800 funds that seemed to have no sense that a correction was possible. As some of those positions are unwound, now that the stock is soundly in correction territory, there has been significant downward pressure on shares. Additionally, because we are talking about institutional ownership, the selling may not be over yet. Despite this, however, the average of analyst targets has only fallen by 7% to $728, a full 33% above current levels.

In addition to the selling pressure created by funds leveling out Apple positions, there are real issues to be addressed. The story that seems to be old news -- and then news again -- is that the company reduced its orders to suppliers by as much as 50%. The report of this by The Wall Street Journal was one of the primary catalysts for Apple's sell-off to the sub-$500 level. If you take the timing out of the equation, there is the very real possibility that demand for the iPhone 5 is waning. This does not mean that Apple should give up on sales, simply that investors need to be realistic.

Other elements of the bear case include reduced sales from the rumor that a revamp of the iPad Mini and other Apple products will be released in March. Anyone on the fence about buying the device without the Retina display may well choose to wait, which could slow sales. Likewise, all of the buzz about the company's release of a "cheap" version of the iPhone 5 has countervailing arguments. Former Apple CEO John Sculley has come out saying that Apple must release a cheaper version of its phone if it hopes to compete in emerging markets, but there is little question that such a move would cannibalize some sales of the higher-margin iPhone 5. In general, the company has had some missteps that have warranted a correction.

The bull case
The arguments for buying the stock are equally plentiful. Under this scenario, the current sell-off can be seen as a "bear trap," drawing in those with a negative view before the stock runs higher. Even Google, which has not experienced the same correction that has plagued Apple, cannot boast the same low P/E multiple; at 11.4, Apple currently trades at roughly half of Google's 22.4 P/E. One might argue that the discrepancy is warranted given Google's dominant position in the smartphone market share race, but Apple's fundamentals are simply too strong to overlook. Google is a must-own stock without question, but the greater near-term opportunity is Apple.

Perhaps more important, Apple is expected to turn in its typical guidance beat next week when earnings are released. Where the company's guidance is for earnings per share of $11.75, the average sell-side analyst estimate is for $13.46 and the independents have it at $15.11, according the research of Fortune reporter Philip Elmer-Dewitt. Apple has a long history of under-promising and over-delivering, so an earnings beat will hardly come as a surprise to anyone.

From a trading perspective, however, the earnings release may be critical. On one hand, if the stock's downward inertia wins the day, earnings may be a case of "sell the rumor, sell the news." On the other hand, investors who have moved to the sidelines are likely looking for the right time to get back into the stock. Positive earnings news may be the excuse that these investors need to flood back into the stock. This could drive shares rapidly higher and leave you wondering what you were waiting for. Recall from above that the average price target remains at $728. Does this mean that those analysts have remained positive, or are they just slow to update their targets?

I like the rubber ball scenario, and I'd would be a buyer anywhere near $500. The stock's ability to quickly shrug off the sub-$500 close suggests that the stock is stronger than you might have thought. At current levels, I maintain that the upside disproportionately outpaces the downside.

Despite its recent backslide, Apple has been a longtime pick of Motley Fool superinvestor David Gardner, and has soared 215% since he recommended it in January 2008. David specializes in identifying game-changing companies like this long before others are keen to their disruptive potential, and he helps like-minded investors profit while Wall Street catches up. I invite you to learn more about how he picks his winners with a free, personal tour of his flagship service, Supernova. Inside, you'll discover the science behind his market-trouncing returns. Just click here now for instant access.


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

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 January 17, 2013, at 5:30 PM, JaanS wrote:
  • Report this Comment On January 17, 2013, at 5:31 PM, dwilh51183 wrote:

    Apple may have pared iPhone production to rebalance inventory or because of lower consumer demand, according to Milunovich. Order cuts may also be due to suppliers becoming more adept at assembling the latest iPhone, reducing the need for excess inventory, he said.

    Milunovich’s projection for 25 million iPhone 5 units to be sold in the quarters ending in December and in March will still be exceeded under the scenario Nikkei reported, he said.

    Exaggerated Reports

    BOCI Research Ltd. analyst Tony Yang in Hong Kong said checks with Apple suppliers failed to produce any signs of “a huge iPhone 5 shipment drop.” Barclays Plc analyst Jones Ku also said there were no indications of a large order cut for speakers made by Shenzhen, China-based AAC.

    “The actual order cut for iPhone 5s in the first quarter is exaggerated,” Ku said in Hong Kong. “The large cut for displays is mainly due to the over-purchase of displays in the fourth quarter.”

  • Report this Comment On January 17, 2013, at 5:34 PM, JaanS wrote:

    Over-owned is an argument for temporary downside only. If this is the only driver downwards, then eventually a stock should return to its "true value," as the market would adjust. In the end, the earnings should have out.

    The stronger bull argument is that "the good days are over." Apple has seen its hay-day, and further growth is limited.

    I am not saying that this is the correct view, only that it should be included.

  • Report this Comment On January 17, 2013, at 5:35 PM, dwilh51183 wrote:

    APPLE ESTIMATES SHOULD HAVE BEEN REDUCED WAY DOWN TO 11.50 A SHARE, BY NOW. THE SHARES HAVE FALLEN FROM 705 DOWN TO 500, DUE TO ALL THE BAD NEWS. I THINK ALL THE BAD NEWS SHOULD BE IN THE STOCK. NO MATTER WHAT THEY SAY THE STOCK SHOULD GO UP, UP, UP

    Again, can you name me ANY other company in the world that makes $60 billion in a three month time frame? I don't think so

  • Report this Comment On January 17, 2013, at 5:45 PM, TimKnows wrote:

    Apple will be trading at a 52 week low very soon, that's a sign of progress isn't it?

  • Report this Comment On January 18, 2013, at 12:35 AM, getarealjob wrote:

    Guys, stop wasting your money! How long have you been trading or investing? Did you develop a high blood pressure or a heart decease? how about a depression?

    For the Devil sake, if you are that smart, why are you reading this?

    Have you ever measured your blood pressure on the earning day

    This whole game is a scam, big players are stealing your money and yet, you go to the library to buy another book on how to screw yourself!!!

    Have you ever measured your blood pressure on the earnings day of a stock you own, what about your relationship, are your breaking all of your promises about the big mansion and the yacht?

    Did you spend hours watching your bucks disappear while you could have spent it to buy your family needs?

    Oh well, Apple is going up OR down and then it is going to re-bounce the opposite direction? Make a guess........

    If there is a trick to consistently win, why are those writers still wasting time writing books, and instructors working their ass off to reach dummies the basics of trading and investing?

    Happiness is in good health, enjoy it while it last because it is not going to last long. especially if you keep burning your nerve system.

    Some old rich people out there are willing yo pay what they have to reverse time and have good health.

    Hope that helps.

    The 33 years old father

    A.H.H

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