Is Apple's Growth Phase Over?

Rahul 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) stock has dropped nearly 10% following its Q4 earnings report. While the company had posted solid top line growth, it’s EPS ($8.67) was a fraction below the consensus estimates. The guidance was another concern as Apple posted conservative guidance with both EPS and Revenue ($11.75, $52 billion) falling below the consensus estimates ($15.46, $55 billion). I believe this was to be expected as Apple had to reach the end of the exponential growth stage that investors were accustomed to. 

High Market Cap = Range Bound Stock

Apple has a current market cap of 567 billion dollars which is ~$50 billion more than the combined market cap of Google, Microsoft, and Facebook. I believe that growth is not a linear phenomenon and every company comes to a stabilization stage. Apple has just become too big to grow anymore. While Apple has been working hard to avoid this as it is working to launch a whole new product line, I believe that Apple is quite likely to end up like Microsoft (NASDAQ: MSFT) when I compare today’s Apple to the Microsoft of the past. In 2002, Microsoft looked solid with high revenues and plenty of growth opportunities. Customers loved the company, the total addressable market was growing, and free cash flow was pretty good. But the company had reached a stabilization status. Over the next ten years, while the company has almost tripled the revenues, its stock prices have only doubled when we look at the split adjusted prices. In the same 10 years Microsoft has launched several versions of Windows and Office, many of which were huge commercial successes; still, Microsoft has not been able to come out of this growth spiral. Apple looks to go down MSFT’s path as the huge growth that the stock ensured in the past is now over and the stock will trade range bound from now on given its huge market cap and the growing competition from peers like Google and Amazon(NASDAQ: AMZN). While many will still argue about the low PE of Apple compared to Amazon, I believe that Amazon’s high valuation is justified as Amazon is still in the process of expansion and is building real wealth with its warehouses, branding, digital products, etc. Further, in view of the upcoming Holiday season, Amazon is the main stock that should capture investors’ attention. According to the Shop.org forecast, online holiday sales will grow by ~12% in 2012 to as much as $96 billion, which will mainly benefit Amazon considering that it was the dominant organization in 2011 online holiday sales. 

Falling Margins and Cannibalization Concerns

Apple recently announced the new iPad Mini. While the product has been announced at a premium price point than its competitors, it still has a lower operating margin than the rest of Apple’s products. This also seems to be the case with the iPhone5. Apple’s gross margin has actually decreased from 47.4% in Q2 to 42.8% in Q3, and a further 280 bps in Q4 according to the guidance provided by Apple. Further, I believe that Apple mini can seriously cannibalize iPad4 sales that were actually not so great even in last quarter as the iPad3 turned out to be a disappointment with its endless similarities to iPad2 while selling at a higher price point. The reasons for believing this is the case is that the iPad mini comes at a relatively lower cost compared to the iPad4, gives you the comfort to work while standing, and you can carry it around in your pocket with its smaller form factor. I believe that Apple could see a hit to the operating margins with the higher cost iPad mini cannibalizing sales of the higher margin iPad.

The Bottom Line:

While I am not anti-Apple, I believe that the stock offers little for long term investors in terms of returns. While the company will continue to post profits YoY and generate positive EPS for the next few years, I believe that the growth stage is finally over and the stock prices are going to trade between $480-680. Apple has matured into a great company, the risks have minimized, but so have the rewards, and hence I would keep a neutral opinion on this stock.

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