A Reality Check for the Most Important Stock

By Steven Heller - October 4, 2012 | Tickers: AAPL, DWA, MSFT, NOK, TWX | 0 Comments

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For an investor, following the developments of the world’s most important companies is as crucial as following macroeconomic trends.  This elite class of companies acts as a force of gravity to the universe of stocks.  Understanding their trajectories may offer clues to where the general market is headed. 

In today’s market, that means keeping up with the developments of Apple (NASDAQ: AAPL).  It’s popular belief to regard the king-of-fruit as the world’s greatest company to mankind.  In the long run, this may or may not prove to be true.  Regardless of beliefs, it doesn’t matter if Apple is the world’s greatest.  What matters is that Apple is currently the most important stock to the market, and this factor alone warrants giving Apple more attention. 

That’s why I’ve begun questioning if Apple’s future will shine brighter than its past.  But before I can determine this outcome, I’ve gone out to set the record straight.       

Resetting Expectations
Apple investors are bullish for many good reasons like explosive growth, high profit margins, and continued innovation.  When a stock produces monstrous returns like Apple has, investors begin extrapolating that the prosperity will continue to infinity and beyond. This practice is dangerous because it evokes greed, which distorts reality.

It’s better to set realistic expectations because the Apple of tomorrow will likely look a lot different than the Apple of yesterday.  Maintaining a balanced view is crucial to becoming a levelheaded investor.  In this sense, a reality check is just what’s needed to counterbalance Apple’s extremely bullish expectations.                     

1. The markets where Apple competes will become mature.  I’m not saying this is going to happen tomorrow, but at some point in the distant future, the market will become saturated, and demand for their products will be less.  However, it’s worth noting that Apple has an incredible track record of captivating the masses when products are refreshed.  In the long run, product refreshes may stabilize demand.
        
2. Apple is no longer the house that Steve Jobs built.  After his passing, the culture has begun shifting away from his operational vision and towards corporate America.  In other words, they’re becoming more generic and are no longer thinking different.  The board didn’t wait long after Steve’s death to issue a dividend and share buyback.  Actions speak louder than words, and these actions show how clueless the board is about continuing Steve’s legacy.  Let me explain. 
   
   Five years ago Apple had approximately $5 billion in cash, and before these announcements, they had about $100 billion.  In five years, they’ve grown their cash position twenty-fold.  When was the last time you made a 20-bagger in five years?  Do you really think you can out-invest Apple?  Apparently the new board thinks you can.         
   
   For the $45 billion the board authorized to this cause, they could’ve bought Time Warner (NYSE: TWX) or Dreamworks Animation (NASDAQ: DWA) and had cash left over. Strategic media acquisitions make a whole lot of sense when you consider Steve Job’s involvement with Pixar and how iTunes is so heavily reliant on content.  And deals like these would permanently secure content.  In the age of digital media, content is the premium spice commodity; controlling this spice makes you king.  Over the long-term, strategic acquisitions have a greater chance of returning more value to shareholders than dividends or buybacks.                          
3. Apple will continue to make mistakes, and the wrong one could put their business at risk.  The Maps fiasco is the most recent edition, but I don’t think this instance will disturb the bottom line.  It would take a much bigger mistake to derail their earnings momentum.  This risk of this happening may be higher without Steve on board.
4. The lack of boldness with the iPhone 5 release hasn’t helped their leading position.  It’s missing wow factor really puts Apple in a vulnerable position for an ambitious competitor. 
   
   Here’s looking at you, Nokia (NYSE: NOK).  Hopefully you can pull off a successful release of your flagship Lumia 920.  Given your track record of failures, the market doesn’t believe in your ability to deliver.  If you can pull it off, you’ll please your overlord, Microsoft (NASDAQ: MSFT) by validating their goal to create a worthy competitor to Apple.  Your product offers promise and innovation not available on iPhone.  But we all know a promise isn’t enough.  Delivery is essential to your future.  This is a great opportunity to strike while Apple is being conservative.               
       
5. No new exciting engines of growth.  Is an iPad mini really that exciting?  Apple has revolutionized many industries it entered, but an iPad mini falls into the evolutionary category.  In fact, a move into the lower end tablet market may cannibalize existing iPad-major sales. 
   
   Also on the rumor front, there has been an endless string that Apple is going to release a full-blown HDTV.  Until this rumor becomes more developed, it’s difficult to know the implications.  
   
   The takeaway here is that Apple’s worst enemy has become their predictable nature.  Breaking this trend would certainly be a welcome addition for shareholders. 

Bottom Line
Apple is no longer the same company it was when Steve Jobs was CEO.  In terms of buying Apple shares today, being realistic and setting a long-term view is a great idea.  The next decade isn’t likely going to be a 90-bagger like the former.  But that doesn’t mean it’s a bad investment.    

Apple shares are currently trading at a jaw-dropping 75% discount to its 5-year historical earnings growth rate.  This 65% annualized growth rate will likely come down in the future because of dividends and buybacks.  Still, analysts believe Apple’s next five years of earnings will grow by 24% each year.  With shares currently trading at almost 16 times trailing earnings, the implied discount is 50% to this future growth rate.  Should investors become convinced that 24% a year of growth is reasonable, multiple expansion will occur, and this alone should beat the market.    

In the end, Apple is the most important stock in the market, it’s trading at a deep discount to growth, and is still poised to outperform the overall market over the long-term.  Just make sure you have the right expectations. 

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