Are Apple Investors Crazy?

So far, investors have been pretty displeased by Apple's (NASDAQ: AAPL  ) recent iPhone update. By the close of trading on Monday, Apple shares had fallen to just $450, more than 10% below where they stood a week earlier.

AAPL Chart

Apple 1-Month Price Chart. Data by YCharts.

Apple's fall seems to be largely a reaction to the company's decision to charge $549 for the unlocked iPhone 5c in the U.S. (and more in most foreign countries). Investors are particularly worried that Apple will struggle to grow without a cheaper iPhone.

However, these concerns are overblown. In fact, Apple's pullback over the past week has created a great buying opportunity for investors who missed out on the stock's summer run-up.

Reasons for panic
Most of the investment community was blindsided by Apple's decision to introduce the iPhone 5c at a premium price point, rather than making it an entry-level phone. Many analysts are now worried that iPhone sales will fall short of their prior estimates, due to the lack of a $300-$400 iPhone.

The iPhone 5c turned out to be more expensive than most analysts expected (Photo: Apple)

If anything, the initial downbeat reaction has been increased by the apparently slow pace of iPhone 5c pre-orders. Apple began taking iPhone 5c pre-orders last Friday, and most colors and options are still available for delivery this Friday (the release date).

Moreover, Apple did not release a pre-order total on Monday, as it has generally done for recent iPhone launches. Analyst Gene Munster of Piper Jaffray believes that customers may have pre-ordered 1 million iPhone 5cs in the first 24 hours of availability, far less than the 2 million iPhone 5 pre-orders achieved in the first 24 hours last year.

Don't sweat the demand
There are a few reasons why investors should take all of these findings with a grain of salt. First, the iPhone 5s -- Apple's new top-of-the-line model -- hasn't even been available for pre-order. Devoted Apple fans are more likely to want the 5s rather than its less-powerful sibling. In the U.S., the $100 price difference between the two models is not a big stumbling block, compared to the overall cost of smartphone service.

Second, some analysts have pointed out that iPhone 5 supplies were very tight initially, due to manufacturing challenges. By contrast, the iPhone 5c's plastic casing and similarity to the iPhone 5 have probably helped Apple avoid similar supply constraints. In other words, it's not necessarily a bad thing that the iPhone 5c is still in stock.

Finally, many smartphone users in the U.S. -- still the largest iPhone market by far -- upgrade every two years. Since the iPhone 4S was released in October of 2011, much of the U.S. upgrade demand may be pushed out to October and thereafter. By contrast, the iPhone 4 was released in June 2010, so last year there were plenty of people who had already reached the two-year mark and were ready to upgrade when the iPhone 5 was released in September.

It's also worth noting that Apple's new agreement with Japan's largest wireless carrier, NTT DoCoMo, opens up a large new market. Apple is already the leading smartphone vendor in Japan, and this partnership should further entrench Apple there. A deal with China Mobile, the largest carrier on the planet with over 700 million subscribers, is probably not far behind.

Margin benefits
Thus, the apparently negative demand data that has trickled out over the last week is not so clear-cut. This is not the first time that Apple-watchers have predicted doom, and so far iPhone sales growth has continued. Therefore, I am inclined to give Apple the benefit of the doubt for now.

On the flip side, as I wrote last week, Apple's new iPhone strategy should be very good for the company's margins. The iPhone 5s maintains the iPhone 5 form factor, which should help Apple avoid a repeat of the spike in production costs seen last fall. Moreover, the iPhone 5c is cheaper to produce than the now-retired iPhone 5, because it uses a plastic casing.

One potential hiccup is that yields for the iPhone 5s fingerprint sensor have been low so far. This could weigh on Apple's gross margin, but more importantly could impose severe supply constraints for several months.

Foolish bottom line
If Apple can ramp production effectively this fall (which primarily means improving yields of the fingerprint sensors), the company should be able to return to solid earnings growth. Last year's drop in margin creates relatively easy comparable earnings figures for Apple to beat.

The margin benefits of Apple's current strategy -- compared to the alternative of releasing a cheaper iPhone -- give Apple the ability to grow EPS even without rapid sales growth. This fact seems to have been overlooked amid all of the panic-selling in the past week. (Moreover, iPhone 5s supply seems more likely to be a constraint on sales than tepid demand.)

Apple trades at around eight times expected fiscal year 2014 earnings, if you subtract its substantial cash reserves. This sort of valuation is only appropriate for a broken company. Savvy investors should therefore view Apple's recent drop as a good buying opportunity.

It's the Apple way
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Read/Post Comments (11) | Recommend This Article (6)

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 September 17, 2013, at 6:33 PM, cazic99 wrote:

    Analysts are either manipulating the stock or just very, very dumb....

  • Report this Comment On September 17, 2013, at 7:01 PM, JAVKO wrote:

    Keep bashing as Samsung pays by the number of words!

    Unfortunately, SEC sstands idly by while WS crooks make money LYING!

    Whoever subscribes to you must truly be a FOOL.

  • Report this Comment On September 17, 2013, at 7:09 PM, CalvinballPro wrote:

    Apple is adding markets for a device that it's running out of the ability to produce in sufficient quantity for the markets it has? And it refuses to acknowledge that consumers can get the same value for less cost elsewhere? You know that scene in TV shows and movies when the rescuer is told to stop CPR on a person who is clearly passed on? These analysts aren't there yet, but soon.

  • Report this Comment On September 17, 2013, at 7:27 PM, TMFGemHunter wrote:

    @JAVKO: Did you even read the article? I said that most of the bears' concerns are overblown.

    @CalvinballPro: Apple's top-of-the-line phones are worth the money for people who are going to use them for hours every day for two years. Is it really worth buying a cheaper phone to save $200 if you are going to use it for 2000 hours before all is said and done? Samsung is able to charge essentially the same prices for its top-of-the-line phones for the same reason.

    Also, don't forget that iPhone trade-in/resale values are quite high. So you can recoup a bunch of your money with an iPhone 5/5S if you trade up in 2 years.

    Adam

  • Report this Comment On September 17, 2013, at 7:30 PM, SuntanIronMan wrote:

    @JAVKO

    The author of this article was not bashing Apple or Apple's stock. Quite the opposite, in fact. Mr. Weinberg outright said that "Savvy investors should therefore view Apple's recent drop as a good buying opportunity."

  • Report this Comment On September 18, 2013, at 6:10 PM, cmalek wrote:

    "So far, investors have been pretty displeased by Apple's (NASDAQ: AAPL ) recent iPhone update. "

    It is the traders that are displeased, not the investors.

  • Report this Comment On September 18, 2013, at 7:01 PM, HeyPacketMan wrote:

    There was a time when AAPL announcements left you shaking your head in amazement. They were always "out there" light years ahead it seemed. They invented new markets and breathed new life and excitement into the old, moribund ones. They owned the intersection of art and technology and were pretty damn good at both. They also knew how to create a buzz. Alan Kay, an old friend of Steve Jobs once said, "Steve understands desire."

    Now they seem flat and content to rest on their laurels. They remind me of the '99 Bulls after Michael Jordan really left.

    The rate of innovation has definitely fallen off. Instead of asking what cool, exciting thing will Apple announce next, we're left asking what's Apple doing to recover cratering iPad sales? Where's the big TV platform roll out? Have the best and the brightest cashed out their stock options and called in rich? What's taking so damn long?

    What's needed is a strong, exciting vision. Maybe Tim needs to rifle through Steve's old desk and find a tab of acid.

  • Report this Comment On September 18, 2013, at 8:14 PM, mountain8 wrote:

    Then there was Wednesday.

  • Report this Comment On September 18, 2013, at 10:48 PM, enginear wrote:

    I think @HeyPacketMan has the correct analysis.

    Nobody talked about pricing in the glory days... they knew it was not just expensive, but really expensive. And they were fine with that because is was hip, cool, high(est) tech, simplest, most intuitive... etc., etc.

    They talked about Samsung trying to catch Apple's device standards, but there was no comparison the other direction.

    All that has changed now.

    The question really comes down to this: Can Apple compete in the hardscrabble marketplace with the ones that have come to rule the moshpit the hard way? Time will tell

  • Report this Comment On September 19, 2013, at 8:33 AM, robyrob wrote:

    Question:

    What's fingerprint sensor yield?

    "One potential hiccup is that yields for the iPhone 5s fingerprint sensor have been low so far."

    Thanks

  • Report this Comment On September 19, 2013, at 8:46 AM, mikecart1 wrote:

    As an Apple shareholder I will say this about Samsung:

    I recently saw Samsung's new commercial on TV with their 4x HD TV's that look like TV's within the classic chalkboard frame that swivels and is equally as thin as a chalkboard. This has my attention more than any SmartPhone or iWatch or iXYZ debate.

    Basically Samsung's new futuristic TV is sick. Now where is Apples?

    :)

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