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If iPhone Sales Rebound, Apple Inc. Stock Is Ridiculously Cheap

By Ashraf Eassa - Feb 6, 2016 at 11:15AM

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Investors should keep a close eye on the iDevice maker's upcoming iPhones, as their performance in the marketplace could make-or-break Apple stock.

As of writing, shares of Apple (AAPL -0.14%) trade at a hair more than 10 times trailing-12-month earnings. Ex-cash -- and Apple has around $150 billion in net cash on the books -- the stock looks almost comically cheap.

However, as Apple is very widely followed by many investment professionals, it's hard to imagine that the stock is significantly mispriced either to the upside or to the downside. I believe that this valuation reflects the significant uncertainty that now exists around Apple's iPhone business, which is expected to see a year-over-year decline for the first time ever during the company's fiscal second quarter.

In my view, the fate of Apple stock during the next 12-18 months will be determined by the answer to one simple question: Will iPhone sales return to growth in fiscal year 2017?

If "yes," Apple stock is just ridiculously cheap
There's every chance that the relatively poor performance that everybody expects from iPhone during fiscal year 2016 is due to simply a "perfect storm" of negative factors that aren't likely to repeat anytime soon.

In the current cycle, Apple is facing two major headwinds according to management:

  1. Macroeconomic situation -- Apple executives on the company's most recent earnings call could not stress enough that Apple is currently facing some very difficult (Tim Cook referred to them as "extreme") macroeconomic headwinds.
  2. High bar to clear -- During the call, Cook acknowledged that the immense demand for the iPhone 6/6 Plus last year, as Apple satisfied the long pent-up demand for larger iPhones, is making for some very tough year-over-year comparisons during this product cycle.

Although it's really tough to make a call at this point about how the macroeconomic situation will trend over the next year or so, a nice "side-effect" of what will likely be a down year for iPhone is that the bar won't be set so high.

Additionally, Apple will have the benefit of fiscal year 2017 being a year in which the company introduces a "new number" phone, which should have significant internal improvements, as well as external improvements (industrial design, display, and so on).

At any rate, I believe that if Apple can demonstrate a return to growth in iPhone in the coming fiscal year, then this should allow investors to be more confident in the longer-term future of Apple's iPhone franchise.

If "no"...
If Apple suffers yet another year-over-year decline in iPhones in the coming fiscal year, then I can't imagine that investors will take this well. Apple is cheap now, but significant deterioration in iPhone shipments, and ultimately revenue, will have a major impact on Apple's net income.

At this point, I could see Apple getting hit with a double whammy: earnings multiple compression even from current very low levels -- remember that rival Samsung (NASDAQOTH: SSNLF) trades at around 8.33 times earnings and also has a very large net cash position -- in addition to earnings declines.

This could ultimately be a recipe for a steep decline in Apple's share price.

Watch the iPhone 7 closely
Apple surely realizes at this point the importance of the iPhone 7 to "setting the tone" for the company's business, and ultimately, its share price in the years ahead. I think it will be important for Apple stockholders to pay special attention to the various iPhone 7 "leaks" in the coming months in order to get a good picture of whether the iPhone 7/7 Plus will be enough of a "game changer" to catalyze iPhone unit-shipment growth.

Ashraf Eassa has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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