'Horrible' sentiment caps Apple downside
The company's low valuation, says one analyst, is a security blanket it clings to while working on its next big product.
Apple (AAPL) is the stock institutional investors love to hate these days, but that makes it a stock with a compelling risk/reward profile according to Raymond James analyst Tavis McCourt.
The company’s low valuation – it goes for just 9.3 times expected 2014 earnings – is something of a built-in security blanket, McCourt argues. That should limit downside from what is expected to be another choppy quarter when the iPhone-maker reports April-June results later this month.
"[T]rends at Apple would have to erode meaningfully" for the stock to continue trailing the market, McCourt writes in a note Monday, a development he characterizes as possible, but not likely.
"Sentiment is bad," he continues. "Make that horrible, in the institutional investor community, and ultimately we view this as feedstock for outperformance."
If the rally in Apple’s stock to last September’s $705 peak was based on an overestimation of the company’s ability to keep generating industry-leading results, the sell-off to less than $400 has been just as much an overreaction, with skeptics now dismissing the company’s ability to produce category-defining products once again.
Partially responding to those doubts, chief executive Tim Cook has promised exciting new products coming in the fall. The harshest critics have pointed to similar promises in the past from device makers like Research In Motion (BBRY), Nokia (NOK) and Palm.
McCourt is not in that camp, but acknowledges that Phase 1 of the mobile computing revolution – smartphones and tablets – is "maturing." While Apple still has opportunities there, including with new partners like China Mobile (CHL), the next phase is expanding the iOS ecosystem through autos, televisions and other devices, says McCourt. With Apple’s track record of attracting high-income consumers, its forays into those arenas should come with attractive margins even if it is not a volume leader. (And it may not be, given the likely competition in all of those arenas from Google‘s Android platform, Samsung and others.)
None of this is particularly new thinking, given that the hopes for an Apple-designed TV have been in the market since before the stock peaked, and McCourt does admit as much, noting that year-over-year trends will remain choppy in Apple’s results. Aside from fewer upgrades to newer devices Apple is also facing the anniversary of favorable currency and commodity trends a year ago that will make for tougher annual comparisons.
But McCourt comes back to the valuation argument, pointing to Apple’s 3% dividend yield and its low-to-peers earnings multiples as support for the view that upside in the stock far outweighs the downside. Raymond James rates Apple a strong buy, up from outperform, with a $600 price target.
Jeffrey Gundlach expressed a similar view of the risk/reward with Apple shares on a conference call with investors last week. Calling the business "a cash flow machine," Gundlach said the company’s challenge is to come out with a product that catches on. If they do, "you’ll make some money." If not, says Gundlach, who accurately predicted Apple’s slide last fall, “you’re pretty well protected” at current valuation levels.
Shares of Apple, up 3.4% to $409.92 Monday, are down almost 23% year-to-date. Google (GOOG), up 1.3% Monday, has risen 26% this year.
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Despite its size, the IPO will create just two new members of the 10-figure club from its executive ranks. A few others could net hundreds of millions.
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