Apple Stock: The Next Run Could Come Sooner Than You Think

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Apple (NASDAQ: AAPL  ) shareholders have understandably become very frustrated over the past seven months, as Apple stock has fallen nearly 40% from the all-time high it reached last September. Apple seems very cheap, at just 10 times earnings -- or 6.5 times earnings if you exclude the company's massive cash position -- but that hasn't managed to attract buyers. However, the negativity that has surrounded Apple recently may actually be setting the stage for another big run-up, which could reward the Apple shareholders who have been patient in the face of the stock's downward spiral.

Low expectations
The market's low expectations for revenue and earnings growth are one major reason for optimism about Apple stock going forward. Wall Street already expects tepid revenue growth and a sharp year-over-year EPS decline when Apple reports Q2 earnings later this month. While iPad unit sales will be boosted by the first full quarter of iPad Mini shipments, iPhone and Mac sales are expected to be fairly similar to last year's Q2 totals. Moreover, a combination of higher component costs and lower average selling prices will lead to a significant drop in gross margin; Apple's guidance in January implied that gross margin could fall as much as 990 basis points from the all-time high of 47.4% set in Q2 last year.

Apple's poor recent stock performance can be attributed in part to the company's long string of successes in the five years after the iPhone's launch in mid-2007. That raised the bar so high that the company was bound to disappoint eventually. When it finally happened, Wall Street quickly soured on Apple stock, as seen in the rapid fall of price targets from analysts such as Peter Misek, whose $900 price target of early December became a $420 price target by early March. With many market participants expecting Apple to struggle for a long period of time, any evidence of a return to growth could quickly reinflate Apple stock.

Big opportunities
Yet behind Wall Street's current scorn for Apple and low expectations regarding the potential for innovation there, Apple has a variety of potential catalysts on the horizon. First, new product lines could be released as early as this fall, with an "iTV" the most likely candidate. Rumors of an iTV have been rampant ever since the release of Walter Isaacson's biography of Steve Jobs, since Jobs told Isaacson that he had "finally cracked" the TV. However, Apple followers have been disappointed as purported iTV release dates have come and gone. Today, the market seems to be assigning no value to new product lines, based on the low Apple stock price. I don't know what Apple's next product will be or when it will be released, but I'm very confident that there will be one; Apple's R&D spending grew 40% in the last fiscal year, to $3.4 billion.

Furthermore, Apple will almost certainly release new versions of the iPhone and full-size iPad within the next three to six months. These will restore profit growth -- and hopefully boost Apple's stock -- for different reasons. The next iPhone, widely assumed to be called the iPhone 5S, is expected to be very similar to the iPhone 5, except for the possible addition of a fingerprint reader. The radical changes to the iPhone manufacturing process for the iPhone 5 caused a significant decline in Apple's gross margin. With fewer changes this time around, Apple's gross margin should return to the historically typical range of 41%-43%.

AAPL Gross Profit Margin Quarterly Chart

Apple Historical Gross Margin. Data by YCharts.

A return to higher gross margins later this year will probably drive 15%-20% profit growth for Apple, even with sluggish revenue growth.

Meanwhile, full-size iPad sales have fallen recently because of cannibalization from the iPad Mini. However, the next full-size iPad will probably be thinner and significantly lighter than the current model, which could reinvigorate sales by enhancing portability. I still expect the iPad Mini to be the top seller, but any increase in full-size iPad sales will boost Apple's bottom line, because the full-size iPad produces more profit per device.

New markets
New generations of the iPhone and iPad can briefly boost Apple's sales and profit, but they no longer generate enough growth to drive Apple stock consistently higher. However, many analysts believe that the iPhone 5S -- unlike previous iPhone models -- will be sold by China Mobile (NYSE: CHL  ) , the world's largest wireless carrier. While the iPhone is too pricey for most China Mobile customers, China Mobile has a lot of customers: more than 700 million! This large customer base creates an opportunity to sell tens of millions of additional iPhones annually. Capitalizing on this opportunity could increase EPS by $2-$3, enough to positively affect Apple stock. Apple is also targeting other wireless carriers that it has not previously worked with: most notably, T-Mobile USA, which on Friday began selling the iPhone 5 for $579.99 -- roughly $70 below the official unlocked price.


The iPhone 5 (courtesy of Apple).

Longer-term, while Apple will never offer a low-end iPhone, it's likely to target the mid-range smartphone segment with a phone priced around $300-$350. This would be more expensive than many Google Android phones, but many people are willing to pay a premium for Apple devices. The problem today is that the cost of an iPhone is just too far out of reach. A $300-$350 iPhone would appeal to those individuals while allowing Apple to maintain generous profit margins.

Foolish conclusion
There are numerous catalysts that could drive Apple stock up from its current rock-bottom valuation. New product lines, higher margins resulting from new product releases, higher sales from new carrier partners such as China Mobile and T-Mobile, and long-term growth based on a cheaper iPhone are all potential earnings growth drivers. Some may not pan out this year, but in all likelihood, others will. Apple's valuation implies permanent earnings decline, which seems far-fetched in light of the company's opportunities. We are likely to learn more about what's next for Apple at the company's Worldwide Developers Conference in June. As Mr. Market starts to focus on some of these opportunities rather than Apple's challenges of the moment, Apple stock could begin its next big rally.

There's no doubt that Apple is at the center of technology's largest revolution ever and that longtime shareholders have been handsomely rewarded, with more than 1,000% gains. However, there is a debate raging as to whether Apple remains a buy. The Motley Fool's senior technology analyst and managing bureau chief, Eric Bleeker, is prepared to fill you in on both reasons to buy and reasons to sell Apple and what opportunities are left for the company (and your portfolio) going forward. To get instant access to his latest thinking on Apple, simply click here now.

Read/Post Comments (10) | Recommend This Article (9)

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 April 13, 2013, at 5:32 PM, Jjkiam wrote:

    Yes Apple is doomed! Why would anyone invest in thia dog? It is only - A company with close to @ 150 b in cash equivalents as of the qtr just ended. A company that has the highest levels of user retention and satisfaction. A company with the most unique and increasingly profitable ecosystem in comparison to any of it's competitors. A company that has a strong portfolio of gadgets in the fastest growing mobile segments and has an equally strong probability of releasing new products that drive even more growth.

  • Report this Comment On April 13, 2013, at 7:27 PM, CalvinballPro wrote:

    This relentless fantasizing about Apple is starting to look like a less successful version of the "pump and dump" scheme from The Sopranos.

  • Report this Comment On April 13, 2013, at 7:46 PM, tychicum wrote:

    Blackberry is asking for a SEC investigation into a smear campaign against BBRY. AAPL should be looked into as well.

    I'm not big on conspiracy theory intrigue but there was an obvious coordinated effort by some one in the background to depict perhaps the greatest most successfull turnaround company in all history as a poor investment. With likely $159 Billion dollars under the mattress ... Go figure that one out.

  • Report this Comment On April 13, 2013, at 8:01 PM, NobodysFool111 wrote:

    2 problems with Apple.

    1) What's it's business model like without telecom subsidies?

    2) It learned nothing from it's own history of overpricing it's products (Mac computer) and nearly bankrupting itself.

  • Report this Comment On April 13, 2013, at 8:34 PM, mdl00 wrote:

    These comments are a smear campaign as well from fandroids. Do you realize how flat out stupid you sound when you call the world's most valuable tech company dead?

    @NobodysFool111: Yes, no drop in price for their "overpriced" products, and they still went from bankruptcy to the world's largest company in 2011. So that is not a factor at all.

  • Report this Comment On April 13, 2013, at 9:58 PM, DanManners wrote:

    The problem with Apple is this:

    All of the above could be true but then people say it is the last big growth in earnings because they just can't keep topping themselves with this market cap. The law of large numbers. So they may have better margins but they get a lower multiple put on it.

    Now at 420 per share and $ 150 billion in cash they can increase their dividend and become a value play vs growth. If all of the above comes true, they are due another big chunk of cash in the future.

    I see the downside of $360 into June earnings max and upside of $ 540. Apple is always going to be way cheap from now on. It will never get a decent multiple. I see a p/e of 9 to 10.

    Now in my opinion, Apple should have used their cash to buy other companies. By buying good companies they increase profit and growth can come from purchased growth companies.

    If and when Apple comes out with a new category then the stock could see $ 1000.

  • Report this Comment On April 14, 2013, at 10:36 AM, TMFGemHunter wrote:

    @DanManners: Apple stock got to $700 ($650 billion market cap) last fall, so I don't see what prevents it from getting back to that level if conditions improve. In terms of moving the stock, I think it would be useful for Apple to return some of its cash through a buyback (which would also improve the P/E). Apple's already at a P/E between 9 and 10, so any EPS improvement should be able to move the stock without a big multiple expansion.

    As for growth, I agree that adding a new successful product category would be the most straightforward way to improve Apple's stock price (and P/E). But Apple can't buy growth. Imagine a company is growing revenue and earnings 20%-30%; it probably would have a P/E of at least 30 or 40. Apple would have to pay a buyout premium; say 50X. If Apple spent $100 billion to acquire growth companies at 50X, that would add $2 to Apple's EPS, and improve future earnings growth by around 50 cents a year. Not much bang for the buck.

    By contrast, if Apple spent $100 billion to repurchase stock this year, it would boost EPS to the $55-$60 range. I think that would do a lot more for the stock than adding a little bit of growth through acquisitions.

  • Report this Comment On April 14, 2013, at 10:42 AM, TMFGemHunter wrote:

    @NobodysFool: Apple has been most successful in the U.S., where the subsidy model is common. However, the company still does a LOT of business in international markets where there are no subsidies (or minimal subsidies). And Apple is getting better about that: for example, the recent "trade-in" campaign in India to get the iPhone 4 into a more reasonable price range.

    In the U.S., I really don't think the subsidy model is going anywhere. I've written about this elsewhere, but the top three carriers are stuck in a prisoners dilemma. Sprint would like nothing better than to spend $10 or even $20 billion subsidizing new customers' iPhones if Verizon and/or AT&T were to drop subsidies.

    Even the new T-Mobile plans aren't as revolutionary as they sound. Functionally, the financing option is very similar to a subsidy model.

  • Report this Comment On April 17, 2013, at 1:46 PM, PinkFloydRoadie wrote:

    Wishful thinking here. I still proclaim that Apple will see $370 before returning to $700 and every day it gets closer to that mark. Now I am thinking sub $350 by Q2 earnings announcement. Nope, they are not going to return to glory any time in the next year at least. This is a selling opportunity, not a buying one. I've been out for months and glad I am.

    If the stock goes under $350 and holds awhile, then I might move some of my money from other techs into AAPL, but at long as my other techs are hugely outperforming AAPL, I see no reason to move money.

  • Report this Comment On April 23, 2013, at 10:00 AM, Wynnielady wrote:

    I remember being interviewed by a San Francisco TV station at MacWorld Expo in 1995 about the expectation that Apple was going out of business. I laughed and said look around. The place was packed with humanity. Then I added I think you should go buy some stock. I then took my own advise when I got home.

    Macworld Expo isn't as crowed today because the company opened retail shops all over the USA and the world. They are like the Expo but they are open everyday.

    The Street is bored and the great recession depression isn't over. But when my Old Mac needs to be replaced every 5 years I go get my new one. Sometimes I have to put it off until the next year because I need to save a up a few more shekels. I finally replaced the first iPhone made, last year, because it was so out of date, now it's my Itouch. My poor old iPod just sits in its speaker to play its music.

    So the hedge funds dumped more then a million shares. Of course shorting them before they did. They made money on both ends. They made Apple shares a bubble. But I will still be going to buy my iPad mini as soon as they upgrade it because I'm tired of the weight of carrying around my iPad. There are a billion Mac Heads in China just waiting until they too have saved up their shekels to buy their first IPhone and next their iPad. So Apple just keep on trucking. A Mac Fan

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