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Apple Ain't The Next Polaroid

This article is more than 10 years old.

SAN JOSE, CA - OCTOBER 23: Apple CEO Tim Cook displays the new iPad mini

In one month, euphoria over Apple’s future turned to dust.  The market neither saw a future for General Motors today, tomorrow or next year.  GM still rests at six times forward 12-month numbers.  At some point Apple turns into GM whereby it has discounted everything under the sun.  My guess is we’re more than half way there, too late to sell, but still premature to wade in.

My problem with Apple is I see no natural bottom for the stock.  Unlike banks, you can’t point to net tangible assets per share as a guidepost.  In cyclical sectors like steel, coal, copper, or even aerospace and oil I can model average earning power over a full cycle or even use a discount table on assets in the ground.

With Apple we’re in a no-man’s land.  If they run out of new toys to sell there’s no serious comeback possible.  When the Watsons at IBM bet their company on the development of the 360 computer the space was wide open, competition clearly underdeveloped and unable to catch up.  What scares me about Apple is the competition is comfortably capitalized and knocking on the door.

I see institutional investors paring down Apple from overweighted to equal weighted to underweighted.  We may be there soon which is inherently bullish for the stock if Apple only meets the Street’s much diminished earnings construct.

Ours is a disillusioned age when sluggers on steroids retrospectively get defrocked and Lance Armstrong’s string of trophies turns to dross.  The “fiscal cliff” phrase sums up our interlude of discord.  “Where have you gone Joe DiMaggio…?”

I shoulda sold Apple the day their screwed up map app was uncovered.  This was in retrospect an incredibly potent leading indicator that management, post Steve Jobs, had lost mojo.  I forced myself to write covered calls during the 150-point downswing, but somehow this gave me no satisfaction.  You do what you gotta do to stay in the battle for investment survival.

One of my favorite games is handicapping how much a stock is bound to drop after a disappointing quarterly earnings report.  The median is 5 percent, but more if the headman issues disappointing guidance for coming quarters.  Amplitude of bloodletting relates to the stock’s price-earnings ratio.  The bigger it is the harder they fall.  A tech house at 20 times earnings that disappoints drops a snappy 10 percent.  The reciprocal is true as well.  GM reported its quarter 50 percent above the analysts’ consensus and surged 10 percent overnight.

I’m unlikely to bang out a stock that reflects disappointment in its numbers if I believe it’s a temporary situation.  Examples include IBM, McDonald’s, Express Scripts, Walt Disney and General Electric.  Stocks that I added to on earnings beats embraced Goldman Sachs, Citigroup, JPMorgan Chase and Qualcomm.

Qualcomm is a great antidote for Apple’s heartburn.  Why bang your head against the wall trying to figure out Apple’s gross margin shrinkage in coming years?  Why quibble over share of market imponderables in smartphones, tablets and mini tablets?  Qualcomm is the preferred supplier to practically all smartphone purveyors.  It spends 18 percent of revenues on R & D, staying ahead of the pack.  I’ll take my chances on Apple designing out Qualcomm’s product offerings.

The only issue I need to deal with is when does the market saturation hit the smartphone sector?  I see this as a 2015 – ’16 prospect, too early to discount.  Qualcomm rose 6 percent overnight on a brilliant quarterly report, the restraint being the stock’s relatively high price-earnings ratio. Qualcomm sells at 15 times forward 12 months’ earnings.

The 20 percent foreshortened correction in Apple I take constructively.  At $700 mid-September the analysts’ consensus was uniformly bullish.  I’d say $850 was the 12-month target price, with a few outliers around $1,000.

Curiously, under Steve Jobs, Apple’s quarter-end reviews waxed consistently low ball constructs to the point of being ludicrously bearish on revenues, gross margins and unit shipments.  At the least, this restrained analysts somewhat as they updated earnings models.  Jobs either consciously or unconsciously understood that you never want to disappoint Wall Street or let them get carried away with too expansive projections.

Jobs' astute management of Wall Street’s expectations was pretty successful.  Apple never sold at more than 12 times forward earnings.  Stock market history helped.  Consider blow-ups in the cell phone business – Nokia, Motorola and Research in Motion – all near basket cases thanks to Apple’s and Samsung’s primacy in smartphones.  Nokia prided itself in low cost production of cell phones.  How wrong could management’s read of its business dynamics be?

Apple is no Polaroid.  Technology isn’t passing it by.  It is still the product spec leader in smartphones and tablets but competition has deep pockets and is getting better at the game of quality and timely new products.  Samsung, Google, even Amazon and Microsoft want a bigger piece of the market and they field less pricey offerings.

There’s more than meets the eye here.  The new battleground in terms of building a meaningful profit center relates to content.  Not just books, music and streaming films but mid- and high-end hard goods.  Microsoft is investing $600 million for a modest minority interest in Barnes & Noble’s Nook operation which will lose still several hundred more millions of dollars.  Competing with Amazon who sells at cost their electronic readers is a tough business construct.  Amazon is determined to put book publishers out of business and squeeze to death brick and mortar book sellers.  So far, they’re doing a good job.

Back to Apple.  I’m still seeing analyst projections of gross profit margins in the 43 percent range.  I’m at 40 percent and this could prove optimistic.  If the smartphone sector, Apple’s major profit center, begins to show signs of market saturation these next 12 months, the stock heads much lower.  Expectations in early September that Apple would become the first trillion dollar market capitalization on the Big Board already seem ludicrously naïve.

The market is smart to give Apple no credit for its cash hoard, approaching $150 a share sum.  Use it or lose it.  Most of it’s abroad and taxable.  I see fill-in acquisitions, nothing momentous on the horizon, but this is only my hunch.  Conversely, Apple’s board could go the way of IBM’s construct.  Buy back as much stock as you can afford and bump up the dividend, double digits, annually.  Even be aggressive and leverage the balance sheet to buy back a ton of stock outstanding.  It’s possible but not predictable.

I’m seeing some analysts’ notes suggesting Apple could end up as a $200 stock in a couple of years, but I construe all this bearishness constructively.  This is not the good old days of one decision stocks like Polaroid, Xerox, Eastman Kodak, IBM et al.  They sold for 20 to 40 times earnings and all of them later saw the snarling wolf at the door.

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Apple’s price-earnings ratio is closer to 10 times earnings than 30, reflecting the Street’s point of view that nothing lasts forever.  Apple will always be the contender if not the leader in smartphones and tablets.  Maybe it can build a significant content business.  If it does the price-earnings ratio will levitate because this is a renewable, continuous revenue and earnings stream.

I’m not turning my back on Apple, but for now it’s going to sell at 10 times earnings, too tough to model over the next 24 months.  This is not Best Buy, being torn apart by Amazon or a Polaroid with its head in the sand.  Apple’s the leader but holding on to its hegemony is a tough press.

-Martin Sosnoff: mts@atalantasosnoff.com

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Martin T. Sosnoff is chairman and founder of Atalanta Sosnoff Capital, LLC, an investment management company with $6 billion in assets under management. Sosnoff has published two books about his experiences on Wall Street, Humble on Wall Street and Silent Investor, Silent Loser.  He was a columnist for many years at Forbes Magazine and for three years at The New York Post.  Sosnoff owns personally and / or Atalanta Sosnoff Capital owns for clients the following investments cited in this commentary: Apple, General Motors, IBM, McDonald’s, Express Scripts, Walt Disney, General Electric, Goldman Sachs, Citigroup, JPMorgan Chase, Qualcomm, Google, Amazon and Microsoft.