After an impressive two-year surge that has seen its stock rise more than +200%, shares of Apple (Nasdaq: AAPL) appear to have stalled. The stock has been stuck in a tight range between $300 and $320 for the past six weeks, as bulls and bears have at it.
Yet this stock is far too popular and far too controversial to stay stuck in a trading range for very long. The key question for investors now: Will Apple resume its upward climb toward the $400 mark? Or is the long-awaited pullback that brings shares down to somewhere near $250 close at hand? Here are six catalysts to monitor that could move shares this winter. [Read more about catalysts and how they shape the market's biggest winners]
There's no shortage of reasons to like Apple. Just ask Wall Street analysts. They universally sing the company's praises, and most expect shares to eventually climb to $375 or higher. That's not a huge stretch, as $375 reflects a price-to-earnings (P/E) ratio of just 15 on earnings per share (EPS) of $25 in 2011. (The consensus calls for $22, but since Apple routinely tops forecasts by at least 10%, $25 is the most likely outcome).
Why are analysts so bullish?
1. Quarterly trends are scorching. Apple posted spectacular quarterly results in late October, and it looks very likely that results for the December quarter will be even stronger thanks to holiday spending patterns. For example, Apple shipped 14.1 million iPhones last quarter (up +92% from a year earlier), and analysts think more than 15 million units will be sold in the current quarter. Sales of iPhones may cool a bit in the March quarter, but should go on to hit new heights once Verizon (NYSE: VZ) starts selling its own version of the phone.
2. The Mac is back. Just a decade ago, Apple had a miniscule share of the desktop and laptop computing market as Microsoft (Nasdaq: MSFT) looked set to declare game, set and match. These days, the Mac is on the move, taking market share from the Windows crowd quarter after quarter. Sales of Macs rose +26% in the most recent quarter compared with a year ago, while the PC sector grew less than +10%.
All of this success — every bit of it — comes from the halo effect of the iPod, iPhone and iPad, which all operate in the same eco-system. The rising installed base of Macs (both laptops and desktops) further feeds the virtuous cycle of app development, which enhances the sales proposition of all of Apple's products. The solid performance of Apple's fast-expanding store base also provides a positive feedback loop in terms of attracting new customers.
3. A financial dynamo. Apple generated more than $16 billion in free cash flow in fiscal (September) 2010, boosting its cash holding to $51 billion ($55 a share). Unless Apple makes a major move in terms of buybacks, dividends or acquisitions, cash is likely to exceed $80 billion by the end of 2012. Excluding the current cash balance, shares trade for around 13 times likely 2011 profits. That's a very reasonable multiple in light of the company's strong growth, impressive operating margins (they exceed 25%), and powerful brand.
If you're looking for potential negatives for Apple among the Wall Street analyst crowd, you won't find much. This stock is so universally loved by sell-side analysts, that you wonder why shares can't seem to break past the current trading range, even after reporting such a stellar quarter. But potential red flags surely do exist, including:
4. Yphrum's Law (also known as the opposite of Murphy's Law). Everything that could go right for Apple is going right. The iPad has no real competition, Microsoft has proven to be a feeble foe, and Apple has been able to secure premium pricing for its products. Also, the transition to digitally downloaded music continues (sales at iTunes were up +22% in the most recent quarter).
Yet each of these factors carries the potential for reversals. For example, the iPad will soon have many rivals. The early crop of tablet computers offered by rivals has been uninspiring, but the sheer number that will be on the market could quickly turn this into a commoditized segment with little pricing power. In addition, Microsoft's stumbles are soon to be obscured by Google's (Nasdaq: GOOG) rising momentum. [See: "Apple's Biggest Fear"] Google has the unsportsmanlike habit of giving things away and figuring out how to charge for it later. That can wreak havoc for rivals that like to make profits.
5. Margins headed for a fall? Apple recently caused a dust-up by noting in its 10-K filing that gross margins may drop in the current year. That's understandable. The new line of Macs have received major price drops as Apple finds it increasingly difficult to take further market share while its desktops and laptops are notably more expensive than PC units. Apple has also recently benefited from a fairly benign environment for component pricing, and any spike in costs for memory, touch screens and other outsourced items would surely pressure margins.
6. Early adopters and the weak economy. This final point is the major thesis of the few lonely bears. They contend that Apple has done a remarkable job of generating buzz among the most tech-savvy of consumers. But with those early adopters largely spoken for, these bears question why analysts expect Apple's unit sales to come in at a much higher pace in fiscal 2011, as is reflected in most analysts' earnings models. Apple is expected to boost sales +34% this year. But with rising competition in the tablet and smart phone space, and most of those competing products likely to be priced more aggressively, Apple could lose some major momentum.
To be sure, international sales are likely to spike well higher in the next few years. But global players like Samsung and Acer can't be taken lightly as they push back, either. The bears also wonder if Apple can meet sales targets if the economy remains in a funk. Recent sales data imply that consumers are starting to spend again, but we'd need to see these trends sustained before Apple and others can truly be enthused about 2011.
Action to Take –> Shares of Apple certainly aren't overpriced in relation to near-term sales and profit trends. It's the longer-term trends that are worrisome to some. That's why investors will be closely tracking Apple's operating metrics in the next quarter or two for signs of possible slippage.
Apple is currently priced as if it will be a far larger company in three to four years. Time will tell. If you don't own the stock, best off staying clear — you've missed a great run. A pullback to $250 is the best place to get in, and a move to $400 makes the case to short the stock.
– David Sterman