Apple: Bubble or Bargain?

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Clem Chambers recently told us on Forbes.com why he thinks Apple (NASDAQ: AAPL) is a bubble and why he expects the company has already become the next Microsoft (NASDAQ: MSFT).

His rationale: The companies have eerily similar stories, and to understand where Apple is today, investors need only look back to Microsoft a decade or more ago.

The company used to be the supernatural tech company, unbounded by its technological dominance and smarts.

  • It too had then lost a genius leader.
  • It became the most valuable listed company in America.
  • Its chart is rather similar to Apples (sic).


Subsequent charts compare the steep rise of both companies’ stock prices and show what happened to Microsoft’s stock after that run-up: a big drop that the company still has not recovered from. According to Chambers, this is history repeating itself, and investors would be wise to recognize the similarities before Apple’s bubble bursts.

 

It’s a dooming analysis. But hold on.

Noticeably absent from Chambers’ bearish argument is any mention of valuation. That’s where the two stories differ, and differ considerably.

In the late 1990s, Microsoft’s share price disconnected from its earnings. (As did many tech stocks. See “dot.com bubble.”) That’s where its parabolic rise occurred. The share price significantly outpaced earnings growth for years. The company sold at 35 times earnings in 1996, and 66 times earnings in 1998. By 2000, it was still selling at a multiple near 60, without the growth to back that price.

That’s a bubble.

In the case of Apple, share price has trailed earnings over the past five years. In 2007, Apple sold at 45 times earnings. On Tuesday, it sold for under 13 times earnings.

Apple at a sub-6 PE?
Even after Microsoft’s tumble, it took years for Mister Softy’s earnings to catch up with its valuation. By 2007, Microsoft was consistently selling at a PE under 20.

Apple is a stark contrast. Consider that Apple today already sells more cheaply than Microsoft. If it were to fall to Microsoft’s valuation, it would have to fall up.

Chambers believes Apple will be selling for around $250 a share. He doesn’t mention that would have Apple selling at a price-to-earnings ratio under 6. If that were to happen, Apple would join a group with just two other American large-caps: Ford and Seagate Technologies. Both of those companies were in the red within the past four years.

Perhaps he made no mention of that because it seems untenable.

No Jobs, no growth?
Analysts covering Apple expect earnings to grow at an average 21.9 percent over the next five years. That’s better than a double. If that growth is realized, and Apple in 2017 sells at the same valuation Microsoft does today, the share price would be $1,716, a three-bagger from Tuesday’s opening price.

It’s certainly possible that Apple won't achieve that expected growth. Competition in Apple’s key products -- smartphones and tablet computers -- is fierce. How Apple executes without Steve Jobs remains to be seen. But investors shouldn’t assume the company will struggle without its visionary co-founder, as Chambers seems to imply.

Hewlett-Packard’s heyday came after David Packard and William Hewlett were gone. Nike has continued to thrive since Phil Knight stepped down as CEO eight years ago. McDonald’s success has far outlived Ray Kroc.

The post-Jobs Apple story is just starting to unfold, and it’s a good reason for investors to be a little uneasy -- or alarmed by bearish predictions. But they should also take comfort in knowing that Apple has the earnings to back up its share price, making the steep drop Chambers predicts unlikely.


John-Erik Koslosky owns shares of Apple. The Motley Fool owns shares of Apple and Microsoft. Motley Fool newsletter services recommend 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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