Why Apple Trades Like a Mediocre Company

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

A lot of analysts blog about how Apple (NASDAQ: AAPL) is super cheap.  From their perspective, Apple has a premium brand, a dominant position in the market, and trades at a price-to-earnings ratio that is less than the market's -- actually much less if you take out the billions of dollars of cash that Apple has on its balance sheet.  In fact, reducing Apple's share price by its cash lowers its stock by more than $200. 

So let's explore the possible reasons why Apple currently trades at a price-to-earnings ratio of around 11 (and a forward price-to-earnings ratio of less than 10).  Then lets see how Apple stacks up against the competition: Google (NASDAQ: GOOG), BlackBerry (NASDAQ: BBRY), and Microsoft (NASDAQ: MSFT).

Lack of innovation

Apple's growth was fueled by its innovative products: the iPhone, which Apple took to market more than 6 years ago, and the iPad (basically a large iPhone), a product that is three years old.  But what has Apple done lately?  Not much.  As a result, competitors have caught up, there is little product differentiation, and Apple's once wide profit margins have continued to contract as its products turn into commodities. 

Hard to grow

Not that long ago Apple had a market cap of more than $500 billion.  Nearly every company that I can recall that has hit the $500 billion mark stalled and in some cases even saw their stock prices (and market cap) decline significantly.  Cases in point: Cisco, General Electric, Microsoft and Intel.  

Next consider the abundance of companies that were once considered the mobile-device "leader" such as Motorola, Research in Motion (now BlackBerry), and Nokia -- two of which (BlackBerry and Nokia) are down by more than 95% from their highs in 2008 and 2000, respectively. 

Apple is polarizing

Those on Wall Street either love or hate Apple, there is no in-between.  In fact, analysts were so in love with Apple that the "follow the herd" mentality was clearly evident (meaning that analysts were irrational in their optimism). They believed Apple could do no wrong and the company was destined for a $1 trillion market cap. 

Then reality sunk in and Apple shares sank. Now the pendulum has swung too far in the opposite direction as analysts and investors have prematurely started to talk about Apple's fall from grace.  

Cashing out

Who doesn't own Apple?  That is actually part of the problem.  The heroic rise in Apple's share price resulted in Apple occupying a disproportionately large share of hedge funds' and investors' assets.  As a consequence, many people took profits and steps to reduce their exposure to Apple.  

For instance, even though Apple is roughly 4% of the S&P 500, the average hedge fund only has approximately 2% of its assets in Apple.  When a stock goes up that quickly, investors re-balance their portfolio to reduce risk.       

So how does Apple stack up?

Apple trades at a price-to-earnings ratio of around 11, has a market cap of approximately $400 billion, pays a dividend yield of roughly 2.8%, has sales of slightly more than $169 billion in cash, and net income of about $37 billion. 

Google trades at a price to earnings ratio of around 26, has a market cap of nearly $300 billion, does not currently pay a dividend, has sales of more than $55 billion, and net income of more than $11 billion. 

BlackBerry is struggling to eke out a profit and survive, has a market cap of around $4.5 billion, sales of more than $11 billion, and was not profitable last year. 

Microsoft recently got crushed, dropping by more than 10% on bad news, which shows how analysts respond to bad news in the tech sector.  Still, Microsoft trades at a reasonable price-to-earnings ratio of around 16, has a market cap of more than $264 billion, sales of more than $76 billion, and net income of more than $16 billion.   

Overall, with the exception of Google, all of these companies seem relatively cheap. BlackBerry, once a darling, has a meager market cap of $4.5 billion, making it a potential acquisition target.  Then we have Microsoft, a company that got whacked after its recent earnings miss, which creates an attractive entry point for investors.         

My Foolish take

Analysts were overly bullish on Apple and are now overly bearish.  Many of us conveniently forget that Apple is really a software firm rather than a hardware firm -- and that Apple's value comes from iOS, the App Store, iTunes, and iCloud!  Even though I don't expect Apple to hit $700 a share anytime soon, in a pricey market, Apple is an attractive investment with a healthy 10-15% potential upside over the short term. Perhaps its time you took a closer look for yourself. 

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Ryan Peckyno has no position in any stocks mentioned. The Motley Fool recommends Apple and Google. The Motley Fool owns shares of Apple, Google, 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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