Is The Apple Monitor Telling Investors to Buy on the Dip?

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

As the trading days continue to pass by, Apple (NASDAQ: AAPL)'s fundamentalists increasingly appear to be in a vis-a-vis position with technical analysts. On one side of the aisle, shares of the tech giant are obviously attractive, trading at below-average valuation metrics, from the P/E to the P/C. From a chart-watcher's perspective, however, AAPL is slowly treading into bearish territory, nearing the dreaded "death cross" (see Should You Trade Apple Near the Death Cross?), in addition to seeing high volume on down days, a classic "sell" signal.

Just what is that new-fangled Apple Monitor?

In the midst of this debate, though, investors may have missed one very important piece of information coming from notable Apple analyst Brian White of Topeka Capital Markets. White is known for having one of the most bullish AAPL price targets on Wall Street; he currently holds a $1,111 target on the tech company.

As originally reported by Barron's this week, White reported a massive uptick in his "Apple Monitor" last month. According to Barron's, the Apple Monitor "looks at sales by Taiwanese electronics manufacturing firms that supply Apple, as a sort of proxy," and on a monthly basis, the index rose by 16% in November. This spike is notable, because it is "three times the average increase over the past seven years."

From White's standpoint, the above-average gain "is driven by the strongest new product ramp in the company’s history," but what does it mean for investors? Well for starters, it did predict Apple's disappointing earnings in the company's fiscal third quarter this summer. In June, one month prior to the release of Apple's Q3 results, the Monitor dropped by 13%.

Obviously, it's impossible to know what Apple's top line will be until it reports its first quarter results in late January, but if supplier sales are any indication, we may be in for a positive surprise. On the Street, the consensus revenue estimate is $54.8 billion, which would mark an 18% increase year-over-year. At Apple's current valuation, it seems clear that if the stock were to receive such a positive growth driver, a significant portion of the recent selloff could be erased.

How can everyday investors trade the situation?

Let’s take a quick look at the fundamental side of the argument, which we’d consider to be stronger over the long run compared to any technical signal. At their current market price in the $548 range, shares of AAPL trade at a mere 9.4 times year-ahead earnings, below Google (NASDAQ: GOOG) at 14.9X and IBM (NYSE: IBM) at 11.4X, but above Hewlett-Packard (NYSE: HPQ) and Microsoft (NASDAQ: MSFT), which trade at forward P/E’s of 3.9X and 8.3X.

Now, it’s difficult to gauge exactly how these metrics should compare; after all, they are based on forward earnings estimates, so let’s take a look at those. When taking the average of all sell-side analyst estimates from Finviz, we can see that Apple trumps the competition in this arena, as its consensus annual EPS growth rate is 19-20% through 2017. Google (15.7%), meanwhile, is a few ticks lower, and IBM (9.9%), Hewlett-Packard (2.2%) and Microsoft (9.8%) are all in the single digits.

Next, we can tie both of these indicators – valuation and expectation – together with the elegant yet useful PEG ratio. In layman’s terms, the PEG attempts to quantify how investors are valuing a stock’s growth capability, i.e. it normalizes a stock’s valuation to account for its future earnings potential, or lack thereof.

In Apple’s case, we can see that it sports a ridiculously low PEG ratio of 0.63; typically any figure below 1.0 signals an undervaluation. Taking the stock’s historical mark – averages vary wildly – we can see that this is 25-50% below what Apple’s PEG was in late 2009, when it traded around $200 a share. Even more telling, though, is that Google’s PEG (1.38) is more than twice as expensive as its Cupertino-based competitor, and the same can be said for other close peer Microsoft (1.47).

In short, it looks as though investors are valuing Apple’s earnings potential below tech-giant of yesteryear IBM, and are unfairly discounting the stock to Google, which in reality, is expected to have less earnings growth over the next half-decade. We can clearly see this improper appraisal by normalizing Apple’s valuation based on expected earnings, so now does present a great buying opportunity for long term investors.

For those with a shorter-term focus, we’d understand if you’d like to wait until the company’s first quarter earnings release early next year, but be aware that the Apple Monitor may be predicting a blowout.

How are big-time hedge funds trading the situation?

Even though it’s tempting to think that the smart money –hedge funds and other high net worth investment vehicles – are trading Apple into the ground, the truth, quite simply, is that they aren’t. As we’ve shown in our database on Insider Monkey throughout the year, Apple is the top pick among billionaire money managers, and is loved by the aggregate hedge fund industry as well.

According to our records, which track 400 of the world’s most successful hedge funds, Apple was the top stock pick last quarter, as it was held by 146 of the funds we track, significantly more interest than Google (132), Microsoft (96), IBM (42), and Hewlett-Packard (40). In terms of total capital invested, David Einhorn and Julian Robertson (see Julian Robertson’s top stock picks) have some of the highest concentrations in Apple, as each has over 12% of their domestic stock portfolios invested in the tech giant. Check out the rest of David Einhorn’s massive stock portfolio here, and don’t forget to check back at Insider Monkey for updates on the Apple Monitor.


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