Apple: Reasons for the Fall and What to Do About It

Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Shares of Apple (NASDAQ: AAPL) are down by nearly 25% since their historical highs in September. The media and financial pundits are looking at all kinds of possible explanations for this fall, ranging from outside factors like portfolio rebalancing and tax considerations to company specific issues like market share losses and falling profitability over the next quarters.

Let´s take a look at some of these possible explanations and their implications for long term investors.

Outside Factors

Apple was trading in the zone of $10 at the beginning of 2003, so the current price level in the area of $500/$550 means a stratospheric gain from a long term perspective.  Most investors didn´t get into the position that early, but there were plenty of opportunities to buy over the last few years.

Even those who bought much later are doing remarkably well: those who entered two years ago, for example, are enjoying a gain of more than 60% at current levels. Even after the 25% retrace, the stock has delivered an increase of 35% in the last year, more than double the return of the S&P 500 index over the same period.

For those who have been holding Apple more than a few quarters, chances are the stock has outperformed the rest of their portfolio by a considerable margin. If Apple has done better than the rest of the market, the position has likely outpaced other investments, and rebalancing indicates that the stock should be sold to shift money to other assets. We should keep in mind that some hedge funds and mutual funds have mandatory rebalancing requirements, and Apple is very popular among these kind of investors.

Rebalancing alone isn´t a likely explanation for such a steep decline over the last weeks, but the fiscal cliff and tax considerations can exacerbate these factors. Many investors probably decided to accelerate their sales before they are taxed at a higher capital gains tax rate in the future.

Media coverage can have an important influence on price behavior, especially in the short term.  Apple is the most followed stock in the market, and some media outlets usually exaggerate in order to get more attention from the public.

“Apple Collapsing Again” is a headline which can generate a lot of buzz, but it can also be misleading. Remember: the stock has done badly over the last months, but it has delivered double the returns of the S&P index in the last year, and it has produced spectacular gains on longer time frames.

However, if investors were already considering the possibility of reducing their positions due to rebalancing and/or tax implications, negative press coverage can certainly quicken this decision.

After all, a stock giving back some of its past gains is no such a big surprise, but when the stock is Apple and the fall is steep, it generates lots of interest, and media coverage on the subject can exacerbate feelings of fear and uncertainty regarding the company.

Company Specific Factors

The Apple Maps fiasco and recent management shake ups have likely produced some doubts regarding the company and its new leadership after Steve Jobs. It’s always healthy to watch these things closely, but nothing tremendously bad has happened.

The iPhone 5 is seeing fantastic demand in spite of the mapping mistake, and Apple stores are still a case study in terms of efficiency and customer satisfaction. It looks like Tim Cook decided to make the necessary changes before things got seriously bad, and that sounds like something Steve Jobs would do.

Android is great platform for smart phones, and it’s used by many low cost producers in Asia in addition to the other big player in the industry, Samsung. Google (NASDAQ: GOOG) is also stepping up its competitive efforts in tablets over the following years, and Amazon (NASDAQ: AMZN) is ferociously pricing its Kindle products at aggressively low prices. Given this increasingly competitive environment, some analysts are forecasting that Apple will lose market share in the middle term, both in smart phones and tablets.

This may easily be the case, although I wouldn´t take it for granted, especially in tablets where the iPad is still an undisputable leader. In any case, lower cost players usually get a bigger market share, although not necessarily more profits. Apple is in the business of selling premium products for premium prices, so losing some market share to cheaper products doesn´t mean the company will stop growing –only that other alternatives will grow faster – and Apple can still deliver solid returns even if competitors increase their participation over the following years.

 Profit margins compression is another reason for concern lately. The iPad mini and a wholly renewed line of products can exert some reassure on margins, and this creates uncertainty regarding the future.  Investors need to keep some perspective though, even if profit margins fall over the next quarters, Apple will still be much more profitable than any other big players in the tech industry.

Apple has operating margins above 35% and a Return on Equity ratio of almost 43%. This is considerably above the profitability of companies like Google and Microsoft (NASDAQ: MSFT), and way higher than the profitability of more aggressive growth stocks like Amazon and Facebook (NASDAQ: FB).

Besides, at a P/E near 12 Apple is cheaper than any other company in the table. If the future looks uncertain for Apple, what can we say about Microsoft which is missing out the mobile computing revolution? Amazon has delivered razor thin profit margins for a long time, yet the market is still pricing each dollar of earnings at the online retailer at stratospheric levels. Facebook (NASDAQ: FB) is facing serious challenges when it comes to monetizing its business in the mobile era, but the stock is trading at a particularly high P/E ratio.

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Apple is facing some uncertainties, every company does. But if we compare valuation ratios and profitability levels versus other tech leaders, the stock looks like a screaming bargain. The recent fall can be explained by increased uncertainties regarding the company over the last months, but the magnitude of this drop seems excessive considering the current valuation.

That´s were outside factors come in place, investors and the media were tremendously bullish about Apple back in September when the stock was making new highs, and extreme optimism is a great receipt for disappointment. Concerns have been increasing lately, and this probably triggered an unjustified wave of sales accelerated by the stock´s past performance with its rebalancing and tax implications.

Buying Opportunity

The recent decline in Apple is likely the consequence of a combination of factors, some external to the company and others related to its own fundamentals. The important thing to keep in mind is that at current levels Apple offers a great entry price for long term investors. Investing is about the future, not the past, the risk and reward equation offered by Apple looks very convenient, at least in comparison to other tech leaders.

acardenal owns shares of Apple, Google and Amazon. The Motley Fool owns shares of Apple,, Facebook, Google, and Microsoft and has the following options: long JAN 2014 $20.00 calls on Facebook. Motley Fool newsletter services recommend Apple,, Facebook, Google, and Microsoft. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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