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Apple: Enough Already!

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

At this stage, many Apple (NASDAQ: AAPL) investors are feeling a combination of anger and confusion due to the market´s brutal reaction to the company´s earnings report, falling by more than 10% to $460 on Thursday morning—a loss of nearly 35% from September’s highs.

But before you panic and make a regrettable move, like selling your Apple shares or setting an Apple store on fire, there are some comforting things to consider. Put the torch down and don´t rush into the panic selling spree; it´s not as bad as it seems.

What Happened?

To begin with, let me rephrase the headlines you are seeing everywhere else right now: Apple didn´t miss, it was analysts who missed their estimates. Apple usually downplays guidance, so everyone expects better numbers that what the company projects, but this is still a useful distinction to keep in mind.

Apple reported much better numbers than what it told the markets to expect. But analysts, knowing that the company is famously conservative in its guidance, had higher expectations.

In fact, Apple reported better than estimated earnings per share at $13.81 versus $13.44 expected by analysts on average. Sales were a little below expectations though; the company reported $54.51 billion in revenue versus 54.73 billion expected by Wall Street Analysts.

Revenue growth was 18% annually for the quarter, but if we consider that last year included an extra week, adjusted revenue growth would have been 27%. Earnings per share increased by an adjusted 7% annually. Lower margins were already expected due to new product launches, both gross and operating margins were above estimates.

Looking at the two biggest product lines: iPhone sales increased by a 29% annually - below most estimates- while iPads showed a strong increase of more than 48%. Macs and iPods are being displaced by the iPad and the iPhone respectively, so sales of these products fell during the quarter.

Looking at the post earnings reaction, we could have thought the company was about to go broke soon, but that´s clearly not the case after analyzing the numbers. Apple is still expanding at a healthy rate, the company generated more than $23.4 billion in operating cash flow and now has more than $130 billion in cash and cash equivalents on its balance sheet.

So, why is the stock pluming?

Speculating About the Speculation of Others

"The fact that people will be full of greed, fear, or folly is predictable. The sequence is not predictable."

Warren Buffett

It´s hard to tell why other people decide to buy or sell a stock; many traders – as opposed to investors- are basing their decision on short term price momentum, and this accelerates stock movements, both to the upside and the downside. Everyone sells because everyone else is selling, and they look for reasons – excuses – after pulling the trigger.

The most popular argument on a fundamental basis seems to be something in the lines of: “growth is slowing, and Apple will never go back to the ultra-high growth years when the iPhone was in its initial growth phase”.

This is probably true: even if the iPad continues selling like crazy and Apple launches new and successful products, the iPhone was a very special product. Carriers subsidize most of the price in the US, so Apple gets to sell an expensively high margin product and consumers don´t feel the pain in their pockets that much. That´s a fantastic combination for growth and profitability.

The future, even if it´s really good, will likely not be as extraordinary as the past. But that´s still no reason to sell a company like Apple at these levels.

On Valuation and Expectations

Investing is not about comparing a company versus its own past, it’s about buying high quality businesses at attractive valuations. Apple is still one of the best tech names around the world, and the stock is ridiculously cheap at current levels.

To begin with, at a price of $460 Apple has nearly 30% of its market cap in cash. The company should certainly start putting some of that cash to work, preferably through stock buybacks and dividend increases, because that money is badly employed by earning almost zero returns. But let´s keep one thing in mind in order to maintain perspective: Apple has enough cash in its balance sheet to buy Amazon at its current market cap of 121.4 billion.

The company is trading at a P/E ratio around 10, which goes down to 7 if we net out the cash balance. But let´s forget about that cash for a second, let’s assume that Tim Cook loses all that money playing poker in a tragic night out in Las Vegas. That´s still a more than 50% discount to the average S&P 500 stock, since the index trades at a P/E ratio around 16.

Even Microsoft (NASDAQ: MSFT) is trading at a P/E around 15 this doesn´t make any sense considering that Apple is really hurting Microsoft by cannibalizing PCs with the iPad and Microsoft´s ventures in tablets seem to delivering really dismal results so far. Yet, for some strange reason, investors have decided that a dollar of earnings in Microsoft is worth 50% more than a dollar of earnings in Apple.

That´s Enough!

The extraordinary times of the iPhone high growth stage are over, but it’s time to stop looking at the rear view mirror and put our attention on the road forward. The iPad is still stronger than ever, Apple is has one of the most valuable brands in the world, and a deep ecosystem that provides a fantastic competitive advantage. This is not an average company, far better than that, but it´s trading at a steep discount to the averages and even more so to inferior competitors like Microsoft.

Enough with past comparisons already, investing is about the future, and the future looks good for Apple investors considering the company`s fundamental strengths and dirt cheap valuation levels.

acardenal owns shares of Apple. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple 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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