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Read This Before Selling Apple Stock

By Andrés Cardenal – Feb 10, 2016 at 5:45PM

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Sales will remain under pressure in the short term, but Apple stock looks undervalued, and performance will most probably improve in the years ahead.

Image source: Apple.

There is a lot of negativity surrounding Apple (NASDAQ: AAPL) nowadays. The stock is down by a staggering 28% from its highs of the last year due to concerns about declining sales in the coming quarter. Management is expecting total sales during the March 2016 quarter to be in the range of $50 billion to $53 billion, which would represent a year-over-year decline of 11% at the midpoint. Nevertheless, selling Apple stock at these prices could be a major mistake.

Apple stock looks undervalued
The years of explosive growth are most probably in the past for Apple, however, this is already reflected in the current valuation to a good degree. Apple stock is trading at a price-to-earnings ratio around 10, this is a huge discount versus the average company in the S&P 500 index, which carries a price to earnings ratio around 18.

Growth may be slowing down, but fundamental soundness is unquestionable. Apple owns one of the most valuable brands in the tech industry, the company has nearly $216 billion in cash and liquid investments on its balance sheet, and the business generates huge profit margins in the neighborhood of 32% of revenue at the operating level. Apple produced $27.5 billion in operating cash flow last quarter, and management rewarded shareholders with $9 billion in dividends and buybacks over the period.

When it comes to competitive differentiation, financial strength, and profitability, Apple is far superior to most companies in the market. Even assuming that growth will permanently slow down, the current valuation looks quite attractive for investors in Apple at this stage.

Can Apple jump-start growth?
The iPhone 6 was an explosive success for Apple last year: Many customers were avidly attracted toward the new iPhone models with a larger screen, and Apple registered a big sales increase of 28% during the fiscal year ended in September of 2015. This will make annual comparisons remarkably difficult for Apple in the coming quarters, especially since the iPhone 6s is no game-changer in comparison to its predecessor.

On the other hand, CEO Tim Cook said in the latest earnings conference call that nearly 60% of all iPhone users have not yet upgraded to the iPhone 6 or iPhone 6s. These devices are getting increasingly outdated over time, and Apple users are notoriously loyal to their favorite brand. It doesn't sound too unreasonable to expect improved sales performance from the iPhone segment as more customers upgrade their devices in the coming years. Also, according to Cook the rate of switchers from Android was the highest ever last quarter, so Apple seems to be gaining strength versus the competition in smartphones.

Emerging markets are going through significant economic turmoil lately, yet Apple announced a 18% increase in iPhone unit sales in China last quarter. Similarly, iPhone sales grew 76% in India and more than 45% in Korea, Middle East, and Africa during the period. Even under challenging economic times, Apple is still finding promising growth venues in emerging markets.

It's important to look at quarterly financial reports with perspective: iPhone unit sales grew 22% in the September 2015 quarter, but nobody would reasonably expect that kind of performance to be sustained over several years. Similarly, it doesn't make a lot of sense to expect a sustained decline in iPhone sales only because management is expecting falling sales in the coming quarter. Over a time horizon of multiple years, chances are that iPhone sales will continue moving in the right direction, although at a much slower rate than in the past.

Nearly 68% of Apple total revenue came from the iPhone segment last quarter, so this product will remain crucial for the company in the middle term. However, Apple is also betting on new products and services with initiatives such as Apple Watch, Apple TV, Apple Music, and Apple Pay, among others.

Sales in the services segment grew 26% last quarter, accounting for 8% of revenue during the period. The other products segment, which includes Apple TV, Apple Watch, and Beats, registered a 62% jump in revenue, and it represented 6% of sales during the quarter. These high-growth segments will most probably continue outgrowing the rest of the business in the coming years, and they should have a positive impact on overall revenue growth over the long term.

The main point is that Apple is facing falling sales in the short term, however, that's not a good reason to sell the stock at current price levels. Apple is remarkably cheap considering its fundamental quality, and chances are that revenue growth will improve over the middle term. If anything, the recent decline in Apple stock seems to be offering a compelling opportunity for long-term investors.

Andrés Cardenal owns shares of Apple. 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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