logo
  Join        Login             Stock Quote

What Google, Microsoft Valuations Teach Apple Investors?

 December 07, 2012 10:50 AM
 


(By Mani) Shares of Apple, Inc. (NASDAQ: AAPL) dropped 7 percent in the past five days after a DigiTimes story seeing a sharp drop in component orders by Apple, which hints at lower than expected demand, and an IDC report saying that Apple is losing market share in China.

At this juncture, Apple's stock faces a conflict between valuation and momentum. Its P/E of 12x trailing earnings and 11x forward expectations appears quite inexpensive for a company with a return on invested capital (ROIC) over 30 percent and growth of about 20 percent in the next two years.

On the other hand, slowing revenue and earnings growth along with potentially peaking margins create the kind of negative momentum from which tech investors often flee.

[Related -Sobering Quarter and Guidance for Long-Time Apple Bull]

Apple's multiple has been in a decline since 2009, with its peak coinciding with the release of the iPhone 3GS and before the iPad's debut in mid-2010. Steve Jobs died Oct. 25, 2011, but one might argue that some of the P/E compression has been in part due to investor concerns regarding his health.

"Indeed, the bears argue that his passing puts a permanent pall over innovation at Apple. We are not prepared to call innovation dead," UBS analyst Steven Milunovich wrote in a note to clients.

There are potential advancements including the incorporation of biometrics (fingerprint, optical sensors, facial recognition), a material leap in voice recognition (Siri), new consumer cloud services, or even a step towards augmented reality peripherals.

[Related -Amazon.com, Inc. (AMZN) Q4 Earnings Preview: Will Amazon's EPS Top Street?]

Apple's operating margin has grown from the mid-20s to the mid-to-low 30s thanks to an increasing mix of margin-accretive iPhone sales. Although profitability has improved, revenue growth has been cut in half from 50 percent plus in mid-2011.

At the same time, Android vendors have benefited disproportionately and now constitute 72 percent of global smartphone sales and 35 percent of profits. The success of Android vendors and the entry of lower-priced tablets from Amazon.com, Inc. (NASDAQ: AMZN) have triggered investor concerns that the best days are behind for Apple.

History says that valuations of giants such as Google, Inc. (NASDAQ: GOOG) and Microsoft Corp. (NASDAQ: MSFT) were affected as their businesses matured. Google and Microsoft enjoyed multiple expansion as they reached dominant market shares, but then saw their P/Es decline as earnings growth slowed.

Google's share of search has been steady in the mid-60s the last five years. As its search share peaked, so did its revenue growth. The stock's multiple declined significantly in the second-half of the decade despite maintaining high margins.

Revenue growth has accelerated in recent years as Google diversified into other business lines (DoubleClick, mobile advertising, Android/Motorola), but the P/E has not benefited with some of these additions not earning their cost of capital.

Similarly, Apple's revenue growth is bound to slow given its size, and margins likely are peaking with the iPhone two-thirds of profit.

"We expect Mac and iPad should continue to be successful but at lower margins," Milunovich noted.

Microsoft's P/E declined from its peak during the tech bubble, which coincided with a topping of PC growth. Despite a resurgence in PC sales and Microsoft's earnings growth toward the middle of the decade, the multiple continued to decline.

So, the experience of Google and Microsoft would suggest that an upward re-rating of Apple P/E is unlikely once revenue growth and/or operating margin declines commence. The stock can continue to rise though it is more likely to be through earnings growth than P/E expansion.

Meanwhile, a high P/E depends on the company's earnings in excess of its ROIC, and growth. Generally, investors fail to appreciate the magnitude and type of growth required to support a high P/E ratio. Although Apple's growth is coming down, its ROIC remains high.

"Our conclusion is that it is not over for Apple's stock, but without P/E expansion more moderate outperformance is likely," Milunovich said.

iOnTheMarket Premium
Advertisement

Advertisement


Post Comment -- Login is required to post message
Name:  
Alert for new comments:
Your email:
Your Website:
Title:
Comments:
 

rss feed

Latest Stories

article imageInitial Jobless Claims Rose Unexpectedly

Claims unexpectedly rose in the latest report through last weekend to breach 300,000 for the first time read on...

article imageAll Quiet on the Record High Front

What can we glean from the media’s lack of attention to the market’s recent record read on...

article imageThe Chip Maker Short Sellers Should Be Watching

Investing in semiconductor stocks is always tricky. Industry cycles can lead to bumps in the road for the read on...

article imageChicago Fed: US Economic Growth Slowed In October

The pace of US growth slowed more than expected in October, according to this morning’s update of the read on...

Advertisement
Popular Articles

Advertisement
Daily Sector Scan
Partner Center



Fundamental data is provided by Zacks Investment Research, and Commentary, news and Press Releases provided by YellowBrix and Quotemedia.
All information provided "as is" for informational purposes only, not intended for trading purposes or advice. iStockAnalyst.com is not an investment adviser and does not provide, endorse or review any information or data contained herein.
The blog articles are opinions by respective blogger. By using this site you are agreeing to terms and conditions posted on respective bloggers' website.
The postings/comments on the site may or may not be from reliable sources. Neither iStockAnalyst nor any of its independent providers is liable for any informational errors, incompleteness, or delays, or for any actions taken in reliance on information contained herein. You are solely responsible for the investment decisions made by you and the consequences resulting therefrom. By accessing the iStockAnalyst.com site, you agree not to redistribute the information found therein.
The sector scan is based on 15-30 minutes delayed data. The Pattern scan is based on EOD data.