Apple Is Overvalued, and Rupal Bhansali Thinks It's Time to Short
There's a reason why many investors follow Rupal Bhansali. She is known to make bold moves and is a promoter of active investing strategies that many believe are dead. In January 2019, she became a panelist at the Barron's Investment Roundtable, along with 10 other esteemed professionals that are considered as the smartest minds on Wall Street at present. This is what she had to say to Barron's on Wednesday when asked to name a company that is widely held among investors but worries her:
"Apple is viewed as a technology company, but it is actually a consumer electronics company. They can have either a hit or a miss product and that has enormous implications for revenue. The iPhone was an iconic, revolutionary smartphone. Today, it is no longer as competitively advantaged, and in fact, disadvantaged on many fronts and trying to play catch-up. For its pivot to services, iPhone sales matter. And in the bulk of the services, they are competing against well-endowed companies-Spotify on music and Netflix, Amazon, and Disney on content. They neither have content nor a first-mover advantage. The fact that they are spending $6 billion to build a content library to keep consumers tells me how difficult the core business is. Think about Apple as a blue-chip of yesterday, as opposed to a blue-chip of tomorrow-the worst kind of investment because all the good news is priced into the stock, while the bad news is not."
Apart from Bhansali's stellar track record, there are many reasons to believe that she's right about Apple Inc. (NASDAQ:AAPL) and that investors should avoid investing in the company.
The recent eye-catching gains have deteriorated earnings multiples
Apple is currently trading at a 10-year high price-earnings ratio. As illustrated in the below chart, the earnings multiple has expanded exponentially in the last 12 months, along with the appreciation of the share price.
Source: GuruFocus
The earnings multiple, however, does not represent the true state of company affairs. Apple reported better-than-expected earnings for its fourth fiscal quarter, along with record earnings per share of of $3.03. Services revenue reached an all-time high of $12.5 billion in the quarter. However, none of this can hide the fact that revenue declined 2% for the fiscal year and net income declined by 7%. Not surprisingly, Apple could not offset the decline from its product sales with the growth of services revenue.
Source: Company filings
That said, the company was able to turn things around in the fourth quarter and report an increase in revenue over the corresponding period in the last year. Still, this is not enough to convince me of Apple's ability to offset the expected decline in product sales in the next five years, resulting from very slow growth in worldwide smartphone shipments. Since peaking in the fourth quarter of 2016, smartphone shipments have fallen.
Source: Statista
If ever there was a time in the recent past when Apple shares should have traded at a price-earnings ratio of above 20, it was just before the release of the revolutionary iPhone 6. Right now, shares are trading at an even higher multiple than it did prior to the release of the first-ever iPhone, but the company is not on the verge of releasing any innovative product. Rather, the focus of Apple is to diversify away from product sales and improve its earnings from services.
Share buybacks have supported the earnings per share, not net income
When Apple reported a record earnings per share figure for the fourth quarter of fiscal 2019, many investors took the number for granted and concluded that the profitability of the company is increasing along with the share price, which is not true.
The net income has literally gone nowhere in the last five years, but the earnings per share have increased substantially.
Fiscal year | 2015 | 2019 |
Net income | $53.39 billion | $55.25 billion |
Earnings per share | $9.22 | $11.89 |
Growth |
Source: Company filings
As evident from the above table, the profitability of the company has improved 3.48% in this period whereas earnings per share have grown a staggering 29%, supported by the buyback program that has taken many shares off the market.
Source: GuruFocus
Apple uses cash for these buybacks, which is certainly a good thing for investors. From a mathematical perspective, using excess cash to fund buybacks after allocating sufficient capital to growth operations is accretive to earnings as cash sitting in a bank account earns next to nothing. Considering that the company did not find any attractive investment opportunities, distributing wealth to shareholders seemed to be the right decision. However, this leaves the company with no new streams of significant revenue for the next couple of years.
Takeaway
As investors, it's important to differentiate between a good business and an investment. While Apple is one of the most profitable companies in the world and will likely remain so for many years to come, the significant expansion of the earnings multiple seems irrational as growth opportunities have diminished. It would at least take a few years for Apple TV+ and its other services to gain traction and provide a meaningful contribution to company revenue. All this while, product sales are likely to decline, creating dents in the company's profitability.
The fate of Apple shares in the next few months will depend on whether the company will have a blowout first quarter and the progress of trade negotiations between the U.S. and China. In the long term, shares will follow earnings, like always. The margin of safety that investors could find in Apple shares in the latter half of 2018 seems to have disappeared with the significant capital appreciation in this period. For shares to keep going higher, the company needs to produce attractive results on a consistent basis, which is unlikely to happen given the challenges for the iPhone segment.
A quote by Charlie Munger (Trades, Portfolio) seems to be appropriate to end this analysis:
"No matter how wonderful a business is, it's not worth an infinite price. We have to have a price that makes sense and gives a margin of safety considering the normal vicissitudes of life."
Disclosure: I do not own any stocks mentioned in this article.
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This article first appeared on GuruFocus.
