Apple CEO Tim Cook speaks during the Economic Summit held for the China Development Forum in Beijing ... [+]
A little over a year ago Apple forecast that its revenues would shrink 4% in 2019. Since then, investors have bid up its shares 109% to about $309 — a market capitalization of $1.35 trillion.
Given its modest growth, Apple shares are grossly overvalued. After all, its biggest business — the iPhone — is maturing. Last year Apple suffered a “14% decline in its iPhone business, which accounts for the majority of sales,” according to the Wall Street Journal, even as its second-most important market, China, experienced a downturn.
If you ignore that, Apple’s smaller services and wearables segments are growing — but they are not big enough for Apple’s top line to grow at the double-digit rates that investors expect for FAANG companies. (For example, in its September-ending quarter Facebook reported a 29% rise in revenue and 20% EPS increase, according to the company).
What explains the doubling of Apple shares? My theory is that Apple is going up because it is going up. People do not want to be left behind. So they buy the stock and cling to the aspects of Apple’s story that reinforce their decision to hold on.
A case in point is the hope that Apple will release its first 5G wireless handsets this fall — which the Journal reports will send iPhone shipments up “for the first time since fiscal 2018.” Analysts do not expect the 5G handsets to generate significant revenue until 2021.
Does Apple stock have further to rise? It all depends on whether it reports better than expected growth and raises its guidance. If so, Apple stock will pop — otherwise a plunge is in the offing.
(I have no financial interest in the securities mentioned in this post).
For Apple to beat revenue and earnings per share expectations, it will need to report mere single digit revenue and EPS growth. More specifically, according to the Wall Street Journal, analysts expect Apple to report a 5% increase in revenue to $88.41 billion for the latest quarter and a 9% increase in EPS to $4.54 from last year’s $4.18.
Investors will focus on three Apple business lines:
- Services. Up 19% in 2018’s December-ending quarter, investors are expecting 20% growth for the latest quarter — focusing on the number of subscribers to Apple’s $4.99 a month TV, videogame and credit card services, according to the Journal.
- AirPods. Apple’s wearables business includes those wireless earbuds, iPods and smartwatches. Bernstein Research estimated that AirPod revenues almost doubled to $6 billion in the last fiscal year. After releasing a pricier $250 model last October, Bernstein estimates Apple sold $3.5 billion to $4 billion in AirPods in the December 2019 ending quarter.
- iPhone. 13 years after the iPhone was introduced, the smartphone market is mature and full of competitors. In the third quarter of 2019, smartphone profits declined 11% to $12 billion, according to Counterpoint Research. Apple introduced an iPhone 11 in 2019 at a $50 discount. Bernstein estimates that Apple will need to report a 10% pop in unit sales to offset an 8% decline in average selling price. Investors are also looking for whether Apple will announce a low-cost iPhone in March.
Apple’s business in China is a wildcard — most notably due to the surging coronavirus — which had claimed 106 lives as of January 28, according to Bloomberg. The Chinese government won’t allow Shanghai and Suzhou employees to return to work until February 9 — thereby cutting a week from economic activity there. Two of Apple’s suppliers are in Wuhau — where the coronavirus originated — and “more than 60 [are located] in Suzhou,” according to the Journal.
Is Apple 59% Overvalued?
Apple’s valuation has soared to 27 times trailing EPS — well ahead of its PE of 16 over the last five years.
Apple stock is very pricey on the basis of its price-earnings-to-growth (PEG) ratio which weighs in at 2.52 (a trailing twelve months PE of 27 divided by five year earnings growth of 10.7%, according to YahooFinance).
If you believe that a fair price for a company is represented by a PEG of 1.0 — meaning Apple’s PE equaled that 10.7% growth rate — Apple should trade at $127 (10.7 times its TTM EPS of $11.89, according to Morningstar).
That’s 59% below its current $309 — a level I do not expect to see anytime soon.
However, there are many optimistic assumptions built into its stock price. If Apple beats and raises, I am confident its shares will pop. Otherwise, they have a long journey down to reach fair value.
