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Sunday, December 16, 2012

$AAPL defined by the market

The bullish undertones have left. The action has become a cycle-of-negativity to the perception. Bad news is bad. Good news is warped to be bad.  Negative feedback loops are harsh, obviously. Apple has been in it for 8-9 weeks, although the tone has become much harsher over the last two weeks.

The current market action for AAPL is suggesting a few fundamental themes.

1. A reduction in earnings

The stock's multiple is currently at the very low end. The previous times AAPL has hit these trailing multiples, the stock has rallied. (The first time was after they reported Q1 2012 results. The market had to fill the earnings void. The second time was about 3weeks ago.  The third was yesterday.)

When a stock trades below its average trailing multiple (price-to-earnings ratio), the market is suggesting the earnings will decline. A crude assessment of 2012 indicates Apple's average multiple is 14.  'Reversion to mean' theory would have AAPL trailing multiple around 14.  The current trailing multiple is around  11.5.

In order for the stock to regain a multiple of 14, one of two things need to happen: 1. the stock rises or 2. the earnings decline.

With a trailing multiple of 11.5, the market is saying it expects a 18% decline in EPS for AAPL. ([14-11.5 ] / 14 = 17.8%)  Apple has a current trailing EPS of $44.16. An 18% decline means AAPL will have a trailing EPS of $36.21.

Obviously, the question becomes, do the product trends suggest an 18% decline in earnings?

The most important product trends are the iPhone and iPad. Current chatter:

-increased iOS share since the releases of iPhone 5. (US, Worldwide)

-iPad mini seeing really strong demand. (This is a strong positive being tailored as a negative. Instead of being viewed as gaining w/in the smaller screen tablet space, others point to the cannibalizing of the larger tablet. So they view it as a negative. The negative argument is wrong, and it ignores the increased sales volume, along with the general progression of the tablet space. Classic misrepresentation from people not familiar with disruption.)

I exclude analyst reports in the chatter because they are analysts. Here is how vast their reports vary: Last week one analyst reported an increase in supplier activity. Literally days later, another one reported lower activity. (Coincidentally, the latter report came after the China iPhone 5 debut.  Where, aside from the headlines, the debut was the strongest in the iPhone series. So I consider the latter report suspect. More like bullshit, adjusting the target price due to technicals instead of fundamentals.) But these variations in opinions is why I look at raw data and chatter, not analyst opinions.

China iPhone 5 sales is the one area where the chatter is fuzzy. The raw data suggests good progress. Pre-orders for the iPhone 5 were tracking higher than previous models.  But the perception of weak demand, due to the lack of riots allowed for a lot of misleading chatter, including analyst reports (mentioned above), a China based survey suggesting weak interest for the iPhone 5 (contradicting the pre-order data and grey market facts) and the continued talk of lower iPhone share (even though the same decline in share took place in the US market as it awaited the new phone).

The above chatter in no way suggests an 18% decline in earnings. (An 18% decline in earnings also implies the fiscal Q1 2013 EPS will come in some $5-6 below Apple's own conservative guidance. In other words: Not. Going. To. Happen.)

Since AAPL has not properly traded with its growth rate for some time, the above 'reversion-to-mean trailing PE' thesis could be suspect.  Over the last two years, AAPL has traded with its cash growth position. If we are to assume the trading dynamic holds, the stock will either need to start catching up to the company's cash growth or Apple will find itself $20 BILLION lighter.

Again, the chatter certainly does not suggest billions in losses. And multi-billion dollar acquisitions are not in Apple's nature.

2. a company in decline

That is a loaded assumption, with zero support from the fundamentals and chatter.  The above chatter guides us for an earnings expectation.  There is other chatter that guide us to the internal health of the company.  The chatter includes:

- strong developer support

- competitors keep using Apple products due to the ecosystem stickiness

- iTunes revamp and quick adjustment to the tablet market with the iPad Mini showcase Apple's culture of producing quality popular products and services are very much intact.

- A map fiasco (that the iPhone 5 chatter suggests was a non-factor), ultimately led to Google producing a Map App that was far far better than the original. (A little competition goes a long way.)


With the stock trading near 508, AAPL is discounting a lot of negativity. A level of negativity that would suggest a secular decline in mobile computing growth or a severe disruption to their product lineup.  However, given the overall chatter, the level of negativity the market is projecting is simply not there.

Update: China iPhone 5 sales are no longer "fuzzy". Two million over the weekend.  The UBS Report was bullshit. As for Citi's downgrade right before the numbers were released, looks like they should not have fired Mahaney.

Update 2: chatter has resurfaced regarding Dropbox. If Apple takes the opinions of an influential blogger seriously, this would imply about a $4-8B acquisition. (Dropbox was valued at $4b from its last round of funding in April 2012.) IMO, this purchase would have a positive effect because it would alleviate Apple's need to improve web services.

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