Will Apple Close the Gap?

Following yesterday's minor losses, stocks have made small gains this morning, with the S&P 500 (SNPINDEX: ^GSPC  ) up 0.11% and the narrower, price-weighted Dow Jones Industrial Average (DJINDICES: ^DJI  ) up 0.2% to an even 14,000 as of 10:05 a.m. EST.

Coca-Cola earnings
Dow component Coca-Cola (NYSE: KO  ) reported results for the fourth quarter this morning, beating the earnings-per-share forecast of $0.44 by a penny (on an ex-items basis). What jumps off the page immediately is that this global company is operating in a two-speed world: low growth (Europe and North America) and high growth (Eurasia, Africa, Latin America, and the Pacific). Europe's weakness is glaring: Net revenue for the region fell 6% year on year in the fourth quarter.

What's Apple worth?
That's one of the questions NYU Professor Aswath Damodaran asks in a commentary (free registration may be required) published on the Financial Times website yesterday afternoon. If you're not familiar with Damodaran, he literally wrote the book(s) on valuation. He's a Fool favorite -- you'll see why if you listen to this interview conducted by my Foolish colleagues Jason Moser and Bryan White last September. Damodaran dispatches this particular question pretty quickly:

Apple (NASDAQ: AAPL  ) has $137bn in cash and net income exceeding $40bn in the most recent year. I estimate that with conservative forecasts -- modest revenue growth (6 per cent) and declining margins -- its value tops $600 per share. You can arrive at a value of $460 -- close to the current stock price -- with no revenue growth and significantly lower margins.

That's a critical point, but it is not, perhaps, enough to convince investors to buy the stock. The second question Damodaran considers is whether or how the gap between the shares' current price and their true value is likely to close. Here, he lays out three levers Applecan pull:

  1. Abandon its obsession with secrecy, which is counterproductive with regard to the stock.
  2. Embrace its status as a mature company and return more cash to shareholders.
  3. Move the conversation away from smartphones, a product market that will only become increasingly competitive. One stellar way to do this: Find a new market to disrupt!

Is any of these likely to happen?

No. 2 is the most likely in the near term -- particularly as the company comes under increasing pressure from investors. However, in order to effect a material shift in investor sentiment, No. 3 is the key, in my opinion -- which is a lot more challenging than updating your capital-allocation strategy. Investors may be forced to wait a while before this happens, and the wait would be more bearable if the company were to raise its dividend.

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Are you at ease...or nervous? It's been a great five-year run for investors, with the Dow and S&P at or near all-time highs. Yet fears abound. When will the next downturn hit? Will political gridlock lead to portfolio-killing inflation? To learn how to protect your portfolio, click here for free guidance from the Motley Fool Pro Academy!

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