Why Apple's Pullback Is a Buying Opportunity

Forget for a moment that the stock we are talking about is Apple (NASDAQ: AAPL  ) . If supply constraints are to blame for weaker-than-expected unit sales, pricing is holding, margins are ahead of expectations, and the company is beating earnings estimates, should you buy or sell? Unless the stock is expensive, buy.  Apple isn't the same company it was in 2012; the pullback is likely to be shallower and the upside potential is greater. Here's why.

Now, open your eyes and see that its Apple, the second-largest U.S. company behind Exxon. This company raises many questions in the minds of investors. Can a company this size continue to grow? Last year, Apple shares were crushed back to $385. Could that happen again? Why hasn't Apple released a meaningful new product since Steve Jobs passed? Something needs to change to get the stock back on track in 2014.

The Apple of 2014 is not the Apple of 2012. When Apple began its pullback from $705, Tim Cook had only recently taken the reins. At that time, revenue growth expectations were high, there was no dividend in place, sell-side analysts expected margins to fall from 35% into the 20's, and Android was taking quite a bit of market share from iOS. However, Apple is a much different company today -- margins have stabilized in the high 30's, iPhones and iPads are actively being sold in China and other high-growth markets, news sources are buzzing with new product rumors, and the stock is cheap at 10.5 times next year's earnings and under four times book value.

The valuation and dividend should put a floor under the stock this time
The last time shares of Apple plunged, the shareholder base primarily consisted of growth investors. Because the rapid revenue growth story was over, there was a transition in the shareholder base as value investors stepped back and waited, while growth investors tripped over each other heading for the exits. Today, Apple pays a 2.2% dividend, in line with the seven-year Treasury bond. As an income investor, would you rather own a seven-year bond in a rising rate environment, or shares of Apple?

Apple's next product remains a mystery, but it could be huge for investors
It's probably safe to expect an iPhone with a larger screen, and subsequent sales revenue large enough to move the needle. iPhone product releases have been evolutionary, rather than revolutionary, and many consumers who own an iPhone 4s or 5 would readily upgrade if a device with a noticeably larger screen was released, even if their current device still works fine. Something as dramatic as a shift to a larger screen could cause a substantial upgrade cycle.

A payments business with the potential to be even bigger
According to Apple's advertising literature, the company has nearly 600 million iTunes accounts, each linked to a credit card number. eBay, on the other hand, has 142.6 million accounts . This business also has a transaction margin of 63.5%, which could dramatically increase gross margins as the business scales.

Cook could and should receive some criticism for the lack of new product launches over the last 18 months, but he was attempting to completely refresh the company's development cycle. Up to the point where he took over, Steve Jobs had been leading by example and driving the development of new products. Tim Cook simply can't work this way. He needed to build an appealing environment for engineers to take on the challenges of product development, a huge paradigm shift that couldn't take place overnight.

Despite its size, short term traders seem to manipulate Apple every Friday into the close, when weekly options expire. The company is also fighting with shareholders over what to do with its cash hoard of $137 billion, or $150 per share. Despite these problems, it's difficult to see much downside, yet easy to see tremendous upside. Whether you're buying and holding the stock, writing covered calls, or selling naked puts, the mechanics are less important than being invested in the right companies for the long term, and any company with 600 million happy customers (whether they are loyal or not) is one you should feel comfortable owning at the right price.

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Read/Post Comments (5) | Recommend This Article (2)

Comments from our Foolish Readers

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  • Report this Comment On January 28, 2014, at 7:26 PM, Breaker18 wrote:

    Agree. The author is 100% correct with his analysis

  • Report this Comment On January 28, 2014, at 7:58 PM, larryw101 wrote:

    Spot on !

    Great points.

  • Report this Comment On January 29, 2014, at 12:47 AM, SimchaStein wrote:

    Great points - simple and true.

    How many Apple 'chicken little' news reports have we seen in the last decade?

    Ignore the Nabobs. Buy.

  • Report this Comment On January 30, 2014, at 8:22 AM, irongate wrote:

    all good points... but the greatest catalyst in 2014 will be the day Tim Cook leaves

  • Report this Comment On January 30, 2014, at 9:39 AM, wfpisani wrote:

    David, Interesting article. In my many years of trading there's one thing that I know for sure - Wall Street is not logical. Stock prices don't necessarily reflect strong fundamentals, solid margins, intellectual property investments or brand equity. Instead prices are driven by factors such as market share growth (even at the cost of profit), perception of future innovation, fear, hearsay and emotional hype.

    One thing that Apple has failed to do - is communicate effectively - to investors and even to their customers. Their secretiveness/ego often gets in the way. Wall Street hates surprises, and Apple needs to better manage this aspect of their business.

    Regarding innovation - the perceived need to come out with a new product every 3-4 months is absurd. The press, the street, and even consumers are now programmed to think this way. Apple's competitors are incremental in terms of innovation (Google dabbles in interesting projects, but has yet to monetize any of them - yet they are great PR stunts for the company). The truth is - REAL innovation takes time ... and Wall Street is short-sighted and impatient.

    I'd personally like to see Apple make some strategic acquisitions with their cash horde - what if Apple bought for example: NUAN or ARM - software & hardware technologies that their competitors also rely on. That would be interesting.

    -Bill Pisani

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