The Day Apple Peaked

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

Apple (NASDAQ: AAPL) still remains one of the most popular brand names in America and I expect this holiday season the Cupertino giant will sell tens of millions of iPads and iPhones. Back in late September when the stock peaked, Apple was the most loved stock in America. More than 30 brokerage firms cover Apple and not a single one of them had a "sell" rating. Moreover, several of my colleagues and friends (none of whom are giddy teenagers) couldn't wait to get their hands on the just released iPhone 5.

While the media has reported a number of reasons for Apple's decline the last few months one cannot ignore the fact that the company's growth has slowed down. During the four quarters of calendar year 2011, Apple's EPS grew on average 95% (+92%, +122%, +52%, and +116%). In the first three quarters of this year, the EPS grew an average of 45% (+92%, +20%, +23%). For a company with sales of about $35 billion in the quarter that's all good but as you can see the last 2 quarters were a little slower, and missed consensus views.

The question here is not about Apple's products or customer loyalty. They still make great, high demand products and I still cannot get into an Apple store on the weekend with all the crowds. At some point there is a disconnect between a company's stock price and its business. I think what has happened to Apple is yet another example of contrarian investing. There is an old saying on the street (which I firmly believe) that states "Individuals investors are wrong at the extremes and right in between." Investors were right between $200 and $705 but even Apple is not immune to an extreme situation.

Back in September, everyone owned Apple, the clients in the brokerage houses that cover it as well as individual investors. With everyone owning it who wanted to, there simply was no one left to buy. Couple that with the aforementioned earnings slow down and you have a perfect recipe for a pull back. Of course, no one can predict the exact day or for how long, but certainly the signs were there that would have the true contarian investor concerned.

But the good news is that extremes work in both directions. Soon you get to a point where a stock is despised so much everyone who wants out gets out. Those signs have already appeared. I had to laugh the other day when Citi downgraded Apple after it had fallen >25% and bounced off the $500 level twice. Where were they in September? But I guess that's the job of the Wise, they epitomize the notion of contrarian investing. However, even though they downgraded it they did note a recent dramatic increase in iPhone sales. It appears to me Apple may have an upside surprise next earnings period. But if their EPS somehow continues to decline, Apple is finished as a market leader.

Apple is a good value now because 1) it is despised and 2) is trading less than 9 times earnings. As I mentioned in a previous blog, the $500 price area seems to be a good price to get in if you can or haven't already. But not every stock which is despised or cheap is a good buy. You can be lured into a value trap. A good example in my opinion is Hewlett-Packard (NYSE: HPQ). They have none of the important business characteristics seen in Apple. Take a walk into a Staple's or Best Buy and look at all the companies (eg Acer) that can make the same product at a lower price. They've had as many CEO changes in the last 3 years as there have been Fall seasonal color changes. They are a business in trouble.

But how can you get in at a bottom? No one can predict for sure, but what I like to do is start by buying a half position. So if I wanted to invest $10,000 in Apple I'd buy $5000 now then wait awhile for my next purchase. If it goes up, great I make money and still have the option to add, if it falls, I buy more and lower my cost basis. It's amazing how after well over 100 years of Market action contrarian investing works so well when everyone (including the Wise) speaks of it. But I guess the one thing which never changes is human emotion.

sabatuj is short Apple puts. The Motley Fool owns shares of Apple. Motley Fool newsletter services recommend Apple. 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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