Apple stock has experienced a decline of about 18% from its all time high on September 19th. This rapid decline in the stock price in the last few weeks has many asking the question “has the stock peaked?” A historical view of other $500B+ market capitalization companies and the analysis of some simple investing basics suggest that the stock probably has peaked in my view.
It Is Difficult To Hit And Remain A $500B+ Market Cap
Lets start with a historical perspective of companies that reached a market capitalization of $500B. U.S. listed companies other than Apple that I found searching through various public sources that approached or exceeded a market capitalization of $500B were Cisco, Microsoft, Exxon Mobil, PetroChina and GE. Cisco. GE and Microsoft reached their peaks in market cap during the peak of the stock market bubble in 2000 while PetroChina and Exxon Mobil hit their peaks during the Energy boom peak in October of 2007. In all these cases, however, sustaining stock price appreciation post a $500B market capitalization proved to be impossible. Take a look at the respective stock charts of these five companies below taken from Yahoo Finance.
Apple’s Entry Into the $500B+ Market Cap Club Most Impressive
What is unique about Apple breaking the $500B market cap barrier and reaching a market capitalization in mid September at about $650B is that it achieved this level of company value without a stock market bubble providing wind in its back via an excessive price earnings multiple. At its peak, Apple’s forward PE ratio was about 13.3, generally in line or slightly lower than the overall market at the time and not high from an absolute basis historically given the average forward PE ratio of the S&P500 since 1976 is about 13x. What is also impressive is Apple achieved the $500B+ market cap level primarily organically without large stock based acquisitions adding to the value of the company. Apple achieved the $500B+ market cap level via its own success of dislocating markets leading to market share gains in multiple markets, namely, the purchase of music, PCs, smartphones and the newly created tablet market. In doing so, Apple extracted significant value from other tech companies in the process, namely, Sony, Microsoft, Nokia, Motorola, HP, Dell and others. So, in a sense, Apple breaking the $500B market cap barrier was the most impressive in my view.
While achieving the $500B+ market cap valuation was achieved in the most impressive manner, the prior five examples show its still challenging for companies to grow market capitalization post $500B. I remember during the 2000 Cisco analyst day when CEO John Chambers was asked how Cisco could continue to grow 30%-50% given its size. John answered back that the size of a company should not dictate its growth rate. Well the rest was history after that for Cisco. The size of a company and its market capitalization does matter in terms of future growth and market cap appreciation. Companies simply get too big to grow at historical rates and mature.
A Look At The Trend In Company Fundamentals, Sentiment and Valuation
Now lets look at some simple investment concepts outside of the law of large numbers to see how the stock may fair in the future. The three simple questions I look at regarding any stock are:
- Fundamentals: Are the fundamentals accelerating or decelerating?
- Revenue Growth
- Margin Profile
- Market Share
- Sentiment: Is the stock over-owned or under-owned and is it loved/hated by the sell-side analysts
- Valuation: Is the stock expensive or inexpensive relative to the market and peers
While Apple still has good fundamentals, the fundamentals are now decelerating rather than accelerating. Revenue growth is slowing and margins have peaked and are now contracting. The simultaneous combination of slowing revenue growth and contracting margins occurred in June 2012 quarter. In particular, Apple’s past results and future analyst projections show revenue growth rates of 66%, 45%, 29% and 18% respectively for fiscal 2011, 2012, 2013 and 2014. Apple has also seen its gross and operating margin decline from its peak level in the March 2012 quarter of 47.4% and 39.3% to 40.0% and 30.4% respectively in the most recent September 2012 quarter. In the case of margins, analysts are expecting Apple’s margins to rise again in future quarters. This will be important for the stock, as the lack of margin recovery will lead to further analyst earning estimate reductions. Finally, according to IDC, Apple’s market share in the Smartphone market has fallen from its peak of 23% in 1Q12 to 14.9% in 3Q12. While some might suggest this is due to supply chain issues and a late launch of the iPhone 5 in 3Q, the enormous market share gain of the Android operating system over the same period is concerning for Apple stock. Android share of the smartphone market went from 52.8% in 1Q12 to 75% in 3Q12.
Apple Is Running Out of Massive New Markets To Dislocate
The amazing achievement regarding margins by Apple, is that it has achieved an operating margin of 30%+ as a consumer electronics company. This phenomenal achievement was accomplished by a very sticky ecosystem and a pedigree of innovation that allowed for premium pricing and many successful products in the consumer electronics industry. The question now is whether this innovation will continue at the same pace. I think it will probably not as evidenced by the recent new product introduction of the iPad Mini, which I view as an incremental product, not a breakthrough product like the iPod, iPhone or original iPad. Apple is running out of large markets that it can dislocate with its products. The iPod dislocated the Walkman, iTunes dislocated and Compact Disk market and the way we purchased music, the iPhone dislocated the cell phone market and the iPad created a whole new market while partially dislocating the traditional PC market. The latest innovation from Apple, namely the iPad Mini, is an incremental product not a new market disruption. Its success will likely cannibalize parts of the iPod and iPad markets. And does not offer any major market disruption.
Will Apple Disrupt the TV Market?
Some have suggested that the next big thing for Apple will be the TV market as Apple will sometime in the future enter the actual physical TV market which is about $80B in annual sales globally. While this could be a new large market for Apple to disrupt and be a new catalyst for the stock, I would highlight a couple of key points that may not make the TV market as easy to disrupt as other markets. First of all, profit margins in the TV market are razor thin and well below Apple’s margin. It is also not clear to me how Apple can leverage its ecosystem to charge a premium price for TVs like they do in the tablet and smartphone markets. TVs also take more significant shelf space than tablets and smartphones. Apple stores are not as well suited for selling a broad range of TVs as they are for selling smaller consumer electronic devices. Finally, TVs have much longer replacement cycles of about 7-10 years vs. smartphones of about 2 years and PCs of about 4-5 years. Thus, its not clear to me that Apple will be as successful in entering the TV market as it was in entering its other markets. I also any disruption in the TV market by Apple is likely to be in the form of an adjunct product (e.g. an enhanced version of the current Apple TV product) that can leverage the current Apple ecosystem and add to it enhanced ways of obtaining, navigating and watching video content rather than Apple selling stand alone TVs.
An Over-Owned and Loved Stock
After reviewing the fundamentals, lets look at the sentiment on the stock. Since the stock has fallen 18% over the past month or so, sentiment is clearly not as strong as it was back the summer. However, Apple is still a broadly owned stock by institutions and given its relative market cap to the S&P 500 and to NASDAQ in particular. According to Yahoo Finance there are 50 sell side analysts that rate Apple as Buy/Strong Buy with only 4 that rate the stock as Hold and 2 that rate the stock as Sell/Underperform. This suggests that if Apple stumbles further in future quarters, the sell side analysts are more likely to downgrade the stock than upgrade given the significantly higher number of analysts that are recommending the stock vs. those who are not recommending it. It also suggests institutional investors will be concerned in owning the stock if they do not view it as outperforming the overall market going forward. Note, that Apple has missed 2 of the past four quarters either in terms of revenues, EPS and/or projected guidance vs. street expectations. If this downward momentum continues, we can start to see the street become less positive on the stock, which will limit upward momentum in the stock in the near/intermediate term.
At Least Apple Shares Are Not Expensive
The one thing Apple has going in its favor that will limit downside to the shares is its current valuation. Based on consensus EPS estimates for fiscal 2013 ending September 2013, Apple is trading at a forward PE ratio of 11.2x on fiscal 2013 EPS. That compares to the forward PE ratio of about 13.7x for the S&P 500 and 14.1x for the NASDAQ 100. Thus, Apple is not an expensive stock by any means and if current estimates are not reduced in future quarters, the stock is probably not going to decline much from here. On the other hand, if gross and operating margins do not recover for Apple to prior levels as most analysts have embedded in their models, earnings estimates will be reduced and the stock will see more downside.
Netting It All Out- Apple Likely Peaked
In my view Apple has likely peaked as its market cap is above the precarious $500B+ level while fundamentals are no longer accelerating and the stock is over-owned by institutional investors and loved by the sell side analysts. Its current below market valuation in terms of forward PE ratio, however, keeps the stock from being a short at current levels unless margins continue to disappoint in the future. Successful dislocations of new markets could be the catalyst to drive Apple to all time highs. The iPad Mini is not such a product in my view as its an extension of the existing iPod/iPad products. Time will tell if Apple can continue to dislocate new markets. If not, the stock could be entering a maturity phase which will not likely allow the stock to hit new all time highs in the future.