Why and How You Should Buy Apple

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

It was almost one year ago when, at the Columbia Investment Management Association's 2012 meeting, David Einhorn, probably one of the best hedge fund managers around, recommended going long on Apple (NASDAQ: AAPL). He was saying that the company was not like any other hardware maker. Apple was not Dell (NASDAQ: DELL), which bases its wonderful numbers on its 'no inventory' production and delivery systems. Apple's business motto went beyond. The company was creating an ecosystem with its iTunes store that would chain customers to all Apple products, from desktop computers to phones and tablets.

Einhorn was saying that Apple was creating something that resembled an annuity because, every one or two years, the already locked-in customers would buy upgraded Apple products again and again. Switching into Google's (NASDAQ: GOOG) Android system was not going to be cheap after you bought all your songs and apps at the iTunes store.

I have to admit, there is some truth to his thesis. At that time, Apple was trading at x10 P/E (when you took off its cash pile), and was growing fast and gaining market share. At that time (February 2012) Apple shares were selling at around $450. Now they sell for $533 after peaking at above $700. Is Einhorn's theory still valid? Should we take advantage of Mr. Market's disenchantment with Apple and go long?

I think yes. Once again, Einhorn, might be right. With $128 per share in cash, and 2013 expected earnings per share at $56, Apple trades at 2013 x7.3 P/E (after taking the cash out of the equation). But multiples are static and Apple is a continued growth story. Remember, 2011 EPS was $28.6, 2012 EPS is expected to close at $45.5, and it's not difficult to think that Apple can grow iPhone unit sales by 45%, tablet sales by 60%, and Macs by 5%. That's the way we can easily compute a $56 EPS for 2013 (23% Year over Year growth) and $65 EPS for 2014 (16% Year over Year growth). We can extrapolate units to earnings because of Apple's great rule of not competing aggressively on prices – the company's cheapest laptop sells for $999. The company is worth its price.

We can dig deeper and try to compare Apple's valuation to other hardware makers with less compelling stories. Dell, for example, sells for 2013 x6.2 P/E and its EPS is not growing. Besides, Dell does not have the ability to build its business the way Apple does. Dell mainly sells - although very efficiently - a commodity: Windows laptops and desktops.

Even Google (Android's maker) seems expensive next to Apple. Yes Google is, in fact, growing at Apple's peace and trades at an apparently cheap 2013 x14 P/E. But, even if its a cash generating machine, its cash goes everywhere but to shareholder's pockets. As a matter of fact, we can think that many of Google investments are more related to the founder's intellectual motivations than to shareholder's interests. Even if this is true, Google is selling at a considerably higher valuation than Apple. Google sells at 2013 x12 price to operating cash flow versus Apple's 2013 x8.5 price to operating cash flow.

I can recommend two trades. One is just going long on Apple shares, and the other one is slightly more complicated. I am proposing to sell a strangle. The bet would allow you to profit if Apple shares stay in between a certain range. I particularly like the strategy that involves selling the January 2013 $525 PUT and selling the $600 CALL option for the same expiration date. The $525 PUT is priced at $17.80 and the $600 CALL is priced at $6.60. So, if Apple goes below $525 by January 2013 you would be buying AAPL at $500.60 and if Apple goes above $600 then you just pocket the two premiums ($24.40). I will explain these strategies in detail at my blog Warrentrades. I would make this last alternative (the one involving options) work for my portfolio. Let's trust David Einhorn on this investment!

martinzaldua has no positions in the stocks mentioned above. The Motley Fool owns shares of Apple and Google. Motley Fool newsletter services recommend Apple and Google. 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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