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Apple Q1 Estimates Plagued by Uncertainty

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

In late January, Apple (NASDAQ: AAPL) will announce its first quarter results, marking the first quarter in which the iPhone 5 was available for the entire quarter. During the quarter, Apple introduced a handful of new products, including the iPad Mini, the 4th generation iPad, and the iMac. As Tim Cook noted in the Q4 earnings call, Apple expects approximately 80% of Q1's revenue to come from new products. With so many new product launches on a larger global scale than ever before, Q1 estimates are plagued by uncertainty.

Last Year's Q1 Results

Last year Apple made history when it fiercely defied the "law of large numbers," reporting a 128% and 111% year over year increase in iPhone and iPad sales, respectively. No doubt these numbers will make comparisons difficult in FQ1 of 2013.

Investors should keep in mind that the iPhone 4S was actually launched during FQ1 of 2012 as opposed to the quarter before (unlike the iPhone 5 which was launched at the end of the Q4). In other words, the iPhone 4S was only available for two and a half months during the holiday quarter last year while the iPhone 5 was available for the full holiday quarter.

To put the severity of last years Q1 blowout into perspective, take a look at the chart below:

<table> <tbody> <tr> <td>Metric</td> <td>Estimates</td> <td>Actual</td> </tr> <tr> <td>Revenue</td> <td>$39.1 billion</td> <td>$46.33 billion</td> </tr> <tr> <td>EPS</td> <td>$10.16</td> <td>$13.87</td> </tr> <tr> <td>iPhones</td> <td>30.2 million units</td> <td>37.04 million units</td> </tr> <tr> <td>iPads</td> <td>13.6 million units</td> <td>15.43 million units</td> </tr> <tr> <td>Gross margin</td> <td>40.7%</td> <td>44.7%</td> </tr> </tbody> </table>

This Year's Q1 Estimates

Unlike the rising bullish sentiment prior to Apple's FQ1 earnings in 2012, analysts have been downgrading their price targets leading up to this year's Q1 earnings announcement. However, investors should keep in mind that analysts average price target of $740 is 39% higher than today's $534 share price for Apple shares.

In other words, tough comparisons in Q1 are already priced into the stock. As Fortune's Apple 2.0 editor Philip Elmer-Ewitt notes, the gap between Apple's stock price and the consensus price estimate is the widest among many other tech stocks, including Google (NASDAQ: GOOG), Amazon, AOL, Microsoft (NASDAQ: MSFT), and HP.

So what are the Street's expectations?

<table> <tbody> <tr> <td>Metric</td> <td>Guidance</td> <td>Wall Street Estimates</td> </tr> <tr> <td>Revenue</td> <td>$52 billion</td> <td>$54.5 billion</td> </tr> <tr> <td>EPS</td> <td>$11.75</td> <td>$13.30</td> </tr> </tbody> </table>

After many Wall Street and independent Apple analysts overestimated revenue and earnings last quarter, estimates have regressed to more conservative levels. For instance, Wall Street only expects Apple to beat its own guidance for revenue and EPS by 4.8% and 13.1%, respectively.

These Wall Street estimates are particularly conservative for two reasons: (1) Historically, Apple's guidance is extremely conservative when compared to actual results; with a 4.8% and 13.1% gap between the Street's revenue and earnings estimates, there is less room for Apple to miss estimates. (2) Revenue and earnings growth tend to obliterate Apple's guidance (and Wall Street estimates) in quarters following an iPhone launch. Consider, for example, that in FQ1 of 2012 Apple guided for about $34 billion in revenue yet actual revenue approached $47 billion. EPS follows the same pattern, with an even larger difference between guidance and actual results in quarters immediately following the iPhone launch.

"Miss," "Solid," and "Blowout" Results

Below are the three key metrics needed to meet the criteria for "miss," "solid," and "blowout" results. I've defined each scenario as follows:

  1. Miss: Results are disappointing; stock price falls.
  2. Solid: Results are as expected; stock price holds.
  3. Blowout: Results surpass expectations; stock price rises.
I've defined each scenario based on "whisper" expectations, which are (in Apple's case) typically slightly higher than published expectations.
 
<table> <tbody> <tr> <td>Metric</td> <td>Miss</td> <td>Solid</td> <td>Blowout</td> </tr> <tr> <td>Revenue</td> <td>$54 billion</td> <td>$55 billion</td> <td>$56.75 billion</td> </tr> <tr> <td>EPS</td> <td>$13.30</td> <td>$13.50</td> <td>$14.40</td> </tr> <tr> <td>Gross Margin</td> <td>38%</td> <td>39%</td> <td>41.2%</td> </tr> </tbody> </table>

The most important metric during the quarter will be earnings per share (EPS). EPS is always important in Apple earnings releases, but there is a differentiating factor this quarter that makes it more important than usual: Currently, Wall Street is forecasting a 4.1% decline in year over year EPS. A decline in Apple's holiday quarter EPS would result in a less favorable P/E ratio, making Apple appear to be more expensive. On the other hand, an increase in EPS would result in a more favorable P/E ratio, making Apple's already conservative valuation appear to be even cheaper.

Conservatism: The Friend of the Long-Term Apple Investor

Fortunately for Apple investors, the recent sell-off from a high of $700 per share just a few months ago has dramatically decreased the downside risk going into Q1 earnings. Considering Apple's impressive ability to turn sales into free cash flow, Apple is conservatively priced in relation to thriving large cap, tech peers like Google, Microsoft, and Intel (NASDAQ: INTC).

Measured by the P/E ratio, Apple is cheaper than both Google and Microsoft, yet more expensive than Intel.

<img src="http://media.ycharts.com/charts/068097a903da5d2ef81ca72f44cd7443.png" />

AAPL PE Ratio TTM data by YCharts

Measured by free cash flow yield, Apple is cheaper than both Google and Intel, while more expensive than Microsoft. Free cash flow yield shows you what percentage of a company's share price is represented by the cold, hard cash it's churning out. The higher this percentage, the better.

<img src="http://media.ycharts.com/charts/e9b15077d1d3686a81d49236c618c566.png" />

AAPL Free Cash Flow Yield data by YCharts

Given the tough year over year comparisons and the uncertainty associated with a handful of new products, a conservative valuation is logical. 

The Bottom Line

A conservative valuation has dampened downside risk to potentially unsatisfactory results. But with so many uncertainties, it is tough to peg a specific estimate to potential upside. No matter the results for the quarter, today's price marks a great point for long-term investors to buy Apple shares.


DanielSparks owns shares of Apple. The Motley Fool owns shares of Apple, Google, Intel, and Microsoft. Motley Fool newsletter services recommend Apple, Google, Intel, 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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