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Apple: Falling Knife or Rubber Ball?

Doug Ehrman
January 17, 2013

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 plen