Why Apple Still Isn’t Cheap
Sam is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Now trading near $400 per share, Apple (NASDAQ: AAPL) appears “cheap” by a number of financial metrics. But investors shouldn't be fooled by the numbers: Apple continues to face serious, fundamental issues with its business and shares could continue to head lower in the coming sessions.
Apple looks cheap
A popular refrain among Apple bulls has been to remark that the stock is cheap. They point to a price-to-earnings ratio lower than the market average, an even lower forward PE, and an enormous cash pile.
By these metrics, Apple is a cheap stock. But it was also cheap at $500, $600, and even $700. Although Apple is now down about 40% from its high last fall, it has never been viewed as an expensive stock.
Last September, when Apple was trading near its peak, Chris Umiastowski wrote a piece for The Globe and Mail entitled, “At around $700, Apple stock is cheap.” From his piece:
“At recent prices just under $700 per share the company is worth $653-billion. Its bank accounts are bulging with $117-billion in cash – roughly 18 per cent of its market cap. Yet the stock trades at only 12.7 times next year’s expected earnings per share. Adjusted for cash, that P/E ratio falls under 11 times...I think the stock is cheap.”
If, in the last six months, someone bought Apple shares because they thought the stock was “cheap” they've lost their shirt. Even at $400, it’s no different today.
Numbers can be deceiving
The problem with this line of reasoning is that financial metrics don’t tell the whole story. Investing is based on the future, not the past. The metrics Apple bulls commonly cite are based purely around what the company has done in the past, not what it’s likely to do in the future.
Its single-digit PE ratio, for example, is a measure of the amount of money the company has generated in the past -- impressive, but not likely to be repeated in the future. The cash pile, too, is only so large because the company has been generating enormous profits -- something that won't happen going forward.
The low forward PE ratio is likewise deceiving. The metric is based on analyst estimates for what the company is likely to earn in the future. These estimates will prove to be overly optimistic, just like the bullish price targets given last fall (notably, Brian White’s laughably absurd $1111 target).
Apple’s business has been commoditized
Apple’s recent rise and fall is not hard to understand. Under Steve Jobs’ leadership, Apple introduced a number of amazing new products the company had a virtual monopoly on. Chief among these products is the iPhone, but also the iPad and going further back, the iPod.
Apple is undergoing a painful transition from a monopolist to a supplier of commodity goods. Basic economic theory dictates that a monopolist is more profitable than a supplier of commodity goods – in a monopoly, consumers have no choice but to buy from Apple. But now, consumers can buy the same goods from many different competitors.
This means that Apple’s profit will continue to come down, either because it will lose potential sales to competitors, or because it will have to cut its prices for the goods it sells.
Google is to blame
Steve Jobs was right to be so angry about Google’s (NASDAQ: GOOG) Android -- it has destroyed the iDevice empire.
A year ago, the iPhone was widely considered to be the best phone on the market. Today, that is far from true. There are a number of handsets powered by Android that are as good or better than Apple’s iPhone -- Samsung’s Galaxy S3 and S4, LG’s Optimus G, and HTC’s One. There’s also Google’s own Nexus 4, which lacks 4G connectivity, but costs less than half the price of an iPhone 5.
But small differences aside, the larger point is simply this: last year, a consumer looking to buy the top smartphone had one choice. Today, they have at least half a dozen. A year from now, there will likely be even more to choose from.
And as Apple loses, Google wins. Although the company does not profit directly from Android (it gives it away for free), Android users are more likely to use Google’s web services -- Google Drive, Google search, Google Docs and Gmail, to name a few.
In fact, as Apple has tried to drive Google’s services from its devices (replacing Google Maps with its own product, booting YouTube off by default) it is more important now than ever before that Android overtake iOS as the dominant mobile operating system both in the US and across the globe. Thankfully for Google, that is only a matter of time.
Don't look to Microsoft’s history for comfort
After experiencing tremendous growth in the 90s, Microsoft started to pay a dividend and its stock cooled off. For the next decade, Microsoft’s stock has traded largely range bound. Some have argued that this will happen to Apple -- that even if its growth is over, the stock will stay in a solid range for the foreseeable future.
Unfortunately, this isn't the case. Although Microsoft has had little growth since the turn of the millennium, its business has not declined -- Windows has continued to dominate the desktop PC market with no legitimate challengers, while Office remains a necessity for business users.
Even now, as its Windows business looks to be fading into irrelevancy, the company is still well diversified and positioned in a number of other sectors: the aforementioned Office, Xbox and its web services.
Apple, on the other hand, remains dependent on the iPhone, and to a lesser extent, the iPad. The market share of these devices is likely to drop significantly in the coming years, as they face more and more Android-powered competition.
In the long-run, both the iPhone and the iPad’s market share might drop to sub 10%, around the level of the Mac’s desktop market share.
The bottom line
Investors should avoid Apple for the time being. While it may look cheap now, it looked cheap when it was trading 40% higher. The company is facing an existential threat from Google’s Android, and unlike Microsoft, it has no monopoly business it can fall back on.
Joe Kurtz 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!