Apple stock, look out below?

Apple Head WindsIs Apple an exceptional company with great products?  Yes.  Does that mean it’s stock price will go up forever?  No.  If you are an investor in Apple Inc (AAPL), you have experienced tremendous gains over the last couple of years.  The stock is up more than 350% since January 2009 and has been the toast of Wall Street every step of the way.  It is a favorite of analysts, hedge funds and money managers the world over.  People are bullish on the company and the stock.  There are calls for Apple’s share price to go to $500, $1000 and well beyond.

In fact it is this incredible bullishness that has me the most worried about the stock and if you are an investor in Apple you might want to be worried too.  We here at Below Your Means are not fans of “buy and hold”, we believe more in buy and watch.  Prudent investors (not traders) need to always be mindful of the every changing fundamentals of the companies and assets in which they invest.  It is with this, that I humbly present:

7 head winds facing Apple:

  1. Everybody that wants an Apple product has one – I think this one speaks for itself.  There is an old saying “invest in what you know” which basically means, when you like a product and your friends like a product and everybody is buying the product; you should buy the stock of the company that makes that product.  Several years back, this was very good advice with regards to Apple.  However as I look around today, literally everybody that I know who wants an iPad, iPhone or likewise has one.  The market for trendy high-end “i” devices appears saturated, at least with in my family and circle of friends.

  2. Competition – Apple is an extremely innovative company, the iPhone, iPod and iPad as well as Apple TV and iTunes have changed the industry.  Apple is good at change.  What it is not good at (at least historically) is taking advantage of that change for the long haul.  Competition is all around.  Android-based phones are now handily outselling iPhones and have been for some time now.  Android based tablets are also starting to shine and by Christmas this year, Android-based tablets will more than likely be outselling iPads as well.

    It’s not just phones and tablets.  Microsoft is making a big push into TV with its newly announced Xbox Live TV and Google TV has already been in the market for a while.  iTunes is also under attack from big players such as Amazon, which is already under cutting prices for music with $0.69 new releases.  For more on the threat from Google go here:

    Google’s excellent execution on the Android Platform | Boom Bust Blog

  3. Margin Compression – Margins are the difference between what something costs to make and what that thing can be sold for.  A company gets to keep the “difference”, which is represented as their profit margin.  With the cost of pretty much everything going on up and competition + a slow economy keeping prices down; the result is the profits Apple enjoys today may not be there tomorrow.  This is especially bad for a company like Apple that relies on cheap labor and raw materials as well as high prices to give them the fat profit margins they have enjoyed in recent years.  But wages are rising rapidly and the cost of raw materials is sky rocketing.  This actually has been showing up in Apple’s recent numbers with gross margins dipping to between 38% and 40%, from last years 40% to 41% range.

    In addition, as Apple tries to compete with lower cost competitors (whose quality is also rapidly increasing), it will have to cut prices, lose market share or compete head on in the “low cost space”.  None of these things are good for Apples margins and none of them are things Apple is historically good at.  For more on how Google is going to hurt Apple’s margins go here:

    How Google is looking to cut Apple’s Margins | Boom Bust Blog

  4. Law of large numbers – In investing terms, this one is pretty simple.  If your are a company with $1 billion in revenue and your share holders expect you to grow by 10% next year, you only have to generate an additional $100M in revenue.  If however you earn $65 billion in revenue and your shareholders expect you to grow 10% next year, you need to generate an additional $6.5 billion dollars in revenue.  That’s a lot of money and represents an insane amout of growth to “move the needle”.   That is just with 10% growth expectations.  According to Yahoo Finance, analysts are looking for revenue growth of 58% this year and 21% next year.  That means they need to sell, $104 billion this year and $120 billion next year.  I don’t want to say this is impossible, but it certainly isn’t easy.  Especially with a slowing economy.

  5. Cash – Apple is sitting on a massive amount of cash.  This currently stands at around $50.8 billion.  Many retail investors see this as a good thing, however if you think about what this means for a minute you will see it may not be as rosy as it would seem.  First, Apple is not alone with having a big cash pile.  Microsoft has $50b, Intel has $12b, and Google has $36b just to name a few.  So this isn’t really an “advantage”, since everyone has it.  Second, the reason a company like this has cash is because it generally doesn’t know what to do with it.  Put simply, they aren’t innovating fast enough and they don’t see innovate companies or ideas they want to purchase or invest in.  So they simply sit on the cash.  This is a sign of the companies’ innovation machine slowing down.  Microsoft suffered from the same thing, many years back and the result was a large one time cash dividend to investors, increase in the companies dividend and a shift of Microsoft from being a growth stock to more of an income stock.

  6. Openness – This is the classic and often opined Achilles’ heel of Apple.  At it’s core (pun intended), Apple is a closed company.  They want to control everything.  They want to control the hardware, the software, the experience and now most importantly the market place (iTunes / App Store).  Apple lost the desktop PC battle to IBM and Microsoft because of this mindset.  Now they risk losing the phone and non-PC device market to the likes of Google for the same reason.  Android is open, very open.  Amazon even introduced a competing App Store.  Where there is openness, there is competition.  Competition drives down prices, increases quality and sparks innovation.  On a long enough timeline, Apple will loose this battle unless they change their ways and embrace a more open approach to growth.

  7. High Expectations and recent weakness – While a few days action, does not a trend make.  The price action of the stock in the last couple days / week has not been very good.  Apple’s stock has dropped from $352 to $332 in in under a week.  This is despite announcing new products at its 2011 developer conference.  Traditionally, new product announcements have been a boom for Apple’s, sending its stock price screaming higher.  Perhaps this sluggishness in the stocks price shows how high investor expectations really are.

 

A few of the items I mentioned above were also mentioned in this article over at Business Insider: The 5 Big Problems with Apple’s Stock.  However, the article is incredible bullish as each “problem” is simply a tee-up for some analyst to say everything is roses and essentially will be forever.  I do not want to sound overly bearish on Apple’s stock, but I do think prudent investors should consider protecting their profits in Apple, should the stock continue to tend down.

For an excellent write up on Apple P/E ration and more head over to Seeking Alpha: Zaky: Apple’s P/E Ratio Falls to Lowest Level Since Financial Crisis Despite 92% Earnings Growth.  Andy Zaky, published another really good read yesterday at Seeking Alpha:  Apple’s Valuation: The One Article Every Investor Should Read

 

Full Disclosure: I have no position in Apple (AAPL) and do not plan on taking any.

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6 Responses to “Apple stock, look out below?”


  1. Hunter

    Convincing argument. There’s also the Steve Jobs factor. Can they continue to innovate after he is gone? I’m not writing him off, but it is well known that he is in poor health, and has also been a remarkable innovative driver.

  2. fgs

    Your cash number is wrong!

  3. Aaron E

    Thanks, I updated it based on the Q2FY11 SEC filing to $50.8 B

  4. Frank

    Regarding your points:
    1st point. Yes it may seem everyone has an Apple device but we in the U.S. are only part of the market segment. Like many companies much of the future of Apples growth is elsewhere in the where they have relatively low market share. Only last week the iPad was released in India and Russia. Listen to the earnings call and I think you will be surprised if not shocked by their growth outside the U.S.

    2nd point. Android is an OS and Google gives it away. Apple sells hardware and makes money. Google STILL makes their money primarily from Adsense.

    3rd point. True over time margins will be less but that is expected as with any company. The issue is by how much.

    4th point. It’s not a law (i.e. unbreakable) just because we haven’t been there. I go back to point 1 regarding growth elsewhere. This is not the 70s where only Americans have money and more importantly people in some other countries (read the big ones) are willing to spend a larger percentage of income on the status of having an Apple product. I have been to a few countries in the past year an everyone that doesn’t have an Apple product either wishes they had one or wants one.

    5th point. Fair point. Yes they have a lot of cash but this means little to shareholders as they beleive they are not going to get it.

    6th point. People will pay a premium for the ease/user experience vs openness. As one Apple exec put it on their conf call, “…we find our customers just want to use the devices how they want and not be systems integrators”. Also if history is an example they are doing fine so far. Apps and songs are up in rev and number being submitted. Over time your point may be taken but so far so good.

    7th point. I can’t predict when a fund manager decides to buy. Currently Apple are out of favor but I believe the growth numbers will become too difficult to ignore and there is no competition whatsoever in the 12-18 month time frame.

  5. Aaron E

    Good counter points.

    For #2, getting market share is key… Apple can make money all day long, but if Android is running on 5 billion devices and Apple sticks around 0.5 B it won’t matter. It will be like Windows vs. Mac OS all over.

    For #4 – Very good point.

    For #6, I can’t find a quote, but I would bet money an Apple exec said the same thing back in 1988.

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