Apple: Rotten to the Core or Just Bruised?

Erick 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) is feeling the weight of the law of large numbers after reporting earnings after hours on Wednesday. The EPS number came in ahead of diminished expectations at $13.81 per share (forecast was $13.47 for consensus and flat year over year) and the revenues were a bit light at $54.5 billion (forecast was $54.8 billion with about 18% growth).

The miss in revenues was only about $250 million, which was easily explained by supply constraints with the iMac and iPhone. The real dagger for Apple was that it forecast lower revenues for the next quarter. Even though the numbers really are not that bad considering the size of Apple, the after-hours market reacted violently to the downside. We shall see if that continues.

Let's look at the numbers critically. Cash went from about $120 billion to $137 billion, meaning free cash flow generation is very healthy. Dividends remain the same for now, but management is looking to repurchase shares to boost EPS. iPhone sales were quite healthy coming at 47.8 million units, and iPad sales were 22.9 million units. The main disappointment was in Mac sales, and that cannot be a big surprise since PCs are a dying market as evidenced by Intel's fall from grace.

I think the market is seriously undervaluing Apple, but this mispricing is likely to persist in the immediate future. The market hates being disappointed, even if its expectations were wildly inflated. 

The market is now favoring Google (NASDAQ: GOOG) as the long-term winner in the race for mobile dominance. To be clear, Android is clearly the market leader, especially at the low end of the market, but is Google worth so much more than Apple? Apple comes with a dividend yield of now more than 2.1%, and a dirt cheap P/E of less than 12 for a premium company that arguably still is one of the leaders in a huge mobile computing marketplace. Google is valued at a P/E of around 30, with the S&P 500 selling as a whole for around 15.

The market continues to be disappointed with Apple's so-called lack of innovation, but I think that Steve Jobs still left some gifts for Apple in terms of innovation that haven't seen the light of day. The history of Apple is full of evolution as well as revolution, and the great Samsung, the big competition in handsets is really not an innovator per se, but a clever immitator.

It's also interesting that Netflix had a huge beat in their latest earnings announcement in contrast to Apple, because more people are streaming shows using Netflix. A lot of those people streaming are using Apple iDevices, and Apple continues to have a lead in the tablets segment, though Android tablets are gaining ground quickly.

If you evaluate the players with fairness in mind, Apple looks quite good, but don't expect the price mismatch to resolve itself anytime soon. That does represent an opportunity for those of us who believe in the long term viability of Apple's business model. Even if full tilt innovation never returns, the value proposition to me remains intact. Growth and margins will decline, but the cash pile keeps growing and that cash pile will eventually ber returned to shareholders.

I have confidence in Tim Cook and the rest of the management. Steve Jobs he is not, for sure, but a capable manager he has proven to be over the last year. Apple may have just jumped the shark from an insanely great company to just a great company. In other words, Apple in my opinion is bruised, but not rotten to the core. 

xerohype owns shares and option calls on Apple and shares in Intel and Google. The Motley Fool recommends Apple and Google. The Motley Fool owns shares of Apple and Google. 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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