Review & Outlook

Our take on the investing, financial, & economic themes of the day

Taking Stock of Apple

25 January, 2013 by Matthew O'Brien, Ph.D. in Commentary

Apple’s stock price has dropped more than 12% since the company’s earnings report on Wednesday.  Now trading at about $447 per share, Apple is down more than 50% from its all-time high of $702 per share in September 2012.  The market has punished the stock because in spite of earning record profits, the company’s growth has slowed markedly and its profit margin has narrowed.

The recent decline of Apple’s stock has been almost as rapid and surprising as its rise over the past several years.  Even with the dramatic downturn in the stock price at the end of 2012, the stock ended the year up 31%, double the return of the S&P 500. Apple is a truly unique company. More than just a company, it is a cultural phenomenon. Among its accomplishments are an ability to continually innovate, a mastery of product design and user experience and a tremendously effective supply chain to keep up with the enormous demand. Even outside of making gadgets virtually everything Apple has tried has seemed to be a huge success whether it was opening retail stores or selling digital music through iTunes.  All of this has produced an almost religious sort of aura around the company and made it for a time the largest company in the world by market capitalization.

So what is going wrong now? The market pays a premium for growth and Apple’s recent earnings report unquestionably shows that growth has slowed.  Consider the recent history of the company’s earnings per share (EPS).

Although in 2012 Apple’s earnings per share increased by a phenomenal 59.6%, this growth was nevertheless weaker than growth in 2010 and 2011.  More importantly, earnings growth in 2013 is estimated to slow to just 9.7%.  A similar story is evident in Apple’s revenue growth.  Also, its gross profit margins have shrunk slightly since a year ago, because the new iPad mini is less profitable than the larger iPad, and sales of the mini may have cannibalized some of the iPad market.

As I noted above, Apple is still a solid company that is tremendously profitable.  It sold a record 47.8 million iPhones in the three months ended December, which was up 78% from the previous year, with total revenues up 18% to $54.4 billion.  With a net profit of $13.81 billion, Apple has a relatively cheap valuation, since its price to earnings ratio is only 10.2.  By comparison, the current price to earnings ratio of the companies in the S&P 500 index is on average 15.48.  Furthermore, Apple’s dividend yield (2.35%) is significantly greater than the yield of US Treasuries (1.9%), and its enormous cash balance could be used to increase its dividend and to buy back stock.

Apple’s recent earnings report and its stock’s nosedive may indicate several different trends.  First, as a company Apple may be maturing, with stable and incremental profit growth replacing the explosive innovation that wooed so many investors over the past few years.  Second, the company’s management may still be somewhat listless after the death of Steve Jobs.  Third, the sheer size of the company may have put an effective cap on its price—with Apple so widely owned across the market its room to grow may have narrowed.

For a long time a string of unbroken successes for Apple set out off an exuberant period where it could do no wrong in the eyes of investors. Now that string has been shattered and it seems Apple can do nothing right in the eyes of the market. The truth is probably somewhere in the middle. Apple remains a highly innovative company with a low PE ratio and a good dividend.

Though we still like the stock’s long-term prospects, we will be watching it closely.  Will the company continue to be more shareholder-friendly than it was in the Jobs era by using some of its vast cash stockpile to pay out dividends and buy back shares? We hope so. Will Apple rest on its laurels or will it come out with some new and unexpected life-changing technology? It’s too soon to say, although if anyone can do it Apple has a good shot.