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Saturday, January 21, 2012

AAPL - potential downside

On Tuesday Apple will report their earnings.  Given the product trends and the lower analyst expectations I am comfortable with the stock going into earnings.

Apple has grown its computer share as the industry declined.  The iPhone has grown its share as the mini computer is adopted by multiple carriers. These gains in share took place with consistent price points.

Last quarter Apple beat their own estimates by 28%, but everyone (wall street and bloggers) pegged their estimates higher than 28% to Apple's estimates.  This go around all estimates are not that high. Wall street estimates have been trending higher over the past few days reaching $10.07.  This is 8.27% higher than Apple's estimates ($9.30).   Blogger estimates are around 11.30 (although these estimates are a few weeks old and I have not seen updated estimates). This is 21.5% higher than Apple's estimates.

Both blogger and wall street estimates are lower than Apple's percentage beat in the pervious weak quarter.

The macro conditions have aligned to give an earnings beat a high probability. (With a relatively strong product pipeline for 2012 including iPhone 4S in China, iPad 3, LTE iPhone 5 and Apple TV prospects are still pretty solid.  I have argued an Apple TV subscription service will be enough to increase Apples multiple as it will usher in the Value Boys in mass.)

For this exercise, lets ignore the above. Lets just assume a realistic potential worse case scenario.  But first, we have to establish Apple's trading dynamic for the last few months.

The last three months for AAPL we have seen a trailing PE ranged from 13-16. (PE data from WolframAlpha)

Despite Apple's continued growth, the 2011 multiple compression was to be expected due to Apple's size. The last three months of the year, the compression was exaggerated as AAPL did not beat analyst guidance by over 28%, and the world economy was in threat of collapse due to EU debt issues, AAPL saw a trailing PE of 13.

So if we assume Apple simply meets wall street's expectations and gives us an EPS of $10.07, its trailing eps will be $31.31. If the market gives Apple's stock a PE of 13 on earnings of $31.31, the stock price will be $407.

Is a trailing PE of 13 justified when AAPL still has revenue growth and eps acceleration? No.

The above assessment is all predicated on a realistic negative extreme, discounting the positive data we already know.  The truth is, AAPL should produce an eps greater than 10.07, and maintain a PE closer to its large cap technology peers, which is around 14-15.  But that is for the market to decide.

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