Since beginning the year, Apple (AAPL 0.51%) shares have underperformed the Nasdaq Composite Index by over 8%, driven by worries about overall iPhone 5 demand and the fear of profit margin declines related to the threat of iPad Mini cannibalization. Simply put, the Street has lost faith in Apple's future earning power and has deeply discounted its growth prospects. A P/E of 11 indicates that the street only expects Apple to grow its future earnings by 11%. Given Apple's massive $472 billion market cap, I can understand where investor justification is coming from. It becomes incrementally more difficult for a company the size of Apple to grow earnings at an increasing rate. As a shareholder of Apple, today I'll be taking the bear side of the argument and will be giving you five reasons to consider selling Apple.
1. Perceived lack of innovation. The iPhone 5 looks a heck of a lot like the iPhone 4S, which looks a heck of a lot like the iPhone 4, and the iPhone 4... well, you get the point. Apple has established an almost uncanny cycle of predictability. While that's good from a consumer expectation standpoint, it's made investors nervous. First, competitors can expect when Apple is going to release a thinner, sleeker, and faster generation of an iDevice, giving them an opportunity to "out-innovate." Second, it leaves little for the imagination, eliminating the element of surprise. There used to be a period when Apple would continuously surprise the world with something new and exciting. Nowadays, Apple's approach is seen as more evolutionary than revolutionary, suggesting the company has grown complacent.
2. Multiple compression. In a five-year period, Apple shares have gained 285%, but over the same period its P/E multiple compressed by 61%. The moral of the story is that Apple investors have shown an unwillingness when it comes to "paying up" for Apple's earnings. This has worked against Apple shareholders by reducing the potential of shareholder return. On a performance basis, the best stocks experience multiple expansion on top of earnings growth because it acts as an additional enhancer to return. Although Apple's earnings growth has been working in the right direction, its P/E ratio has been a serious issue. Dare I say value trap?
3. iPhone 5 slowdown fears. According to The Wall Street Journal, Apple has recently cut iPhone 5 components orders by half, citing weaker-than-expected demand. If true, this softness would not be a good thing for investors, as the iPhone made up over 50% of revenue last year, making it the largest contributor to overall gross profit margin. Since the iPhone 5's gross profit margin starts at 68%, this slowdown could have a negative impact on gross margin and the bottom line. This would not be welcomed news by Apple bulls right now.
4. Developer migration fears. In case you haven't heard, Google's Android OS has grown to reaching 75% worldwide market share. Apple recently prided itself on commanding 75% of the industry's profit with only about 20% market share. However, this dynamic may be at a tipping point. During a recently conducted 20-country study, analytic firm Distimo found that daily revenue for Google Play had grown by 43% during the last four months of the study, handily beating out Apple's 21% comparable growth. If the trend continues, it's just a matter of time until Android brings in more daily revenue over Apple. Many have argued that an ecosystem is only as good as its App Store. If push came to shove and Apple developers head for Android, it could potentially damage Apple's ecosystem and long-term brand image.
5. Low emerging-market penetration. Unsubsidized iPhones are typically more expensive than their Android counterparts, acting as a barrier against Apple's position in lower-income markets. Rumors have been circulating that a lower-priced iPhone is in the works to address this issue. However, it remains to be seen if Apple will extend the reach of its brand in the name of market share.
I'm already an Apple shareholder, so this exercise has allowed me to balance my positively skewed beliefs. As investors, we should consider a diverse range of insights even if we do not share the same opinion. These differences help make us better in the long run. That said, I'll continue to monitor Apple's situation for any material changes, but I still plan on holding my small position for an extended period.
