China: The Elusive Market For US Technology Companies

China ranks as the world’s largest country by population, second in annual GDP and is likely to rank second in terms of total Information Technology (IT) spending in 2013 at about 10% of global IT spending.  It is estimated by industry analysts that China will grow its IT spending by close to 10% per year over the next decade as IT spending only represents about 2% of its GDP which is less than half the level of more developed countries like the US.  While China represents a large and rapidly growing market for US technology companies, the path to success in this market has proven difficult and sometimes impossible due to indigenous suppliers, intellectual property protection and software piracy issues, pricing challenges and other unique market conditions.  China has also grown its own global technology powerhouses in certain industries like communications equipment and personal computers, materially impacting the competitive dynamics for traditional US and European players in not just the China market, but also the entire global technology market.  Finally, China has also developed its own Internet powerhouse companies that have made it difficult for leading US Internet and social media companies to succeed in China.   Is China “friend or foe” for US technology companies, and has history provided technology companies any lessons on sustainable business practices that can be applied to the Chinese market?

 

Over the past three decades there have been many failures and lackluster successes by US technology companies seeking to enter and profitably grow in the China market.  A high profile example was Google, who decided to exit the China market in 2010 after only about five years of formally entering the market with its own development center in China (and an earlier failed attempt to acquire local competitor Baidu).  Baidu’s market share only increased from the mid 40s to the mid 60s in the five years following Google’s entry, which was significantly higher than the 30%-35% share that Google was able to achieve during that period.   While Google pointed to censorship issues as the main driver to leaving the China market, it was also clearly the case that Baidu did a better job of understating the local market (e.g. Mandarin language searches, music downloads that “crossed” the line on piracy issues etc.) which contributed to Google not being a success in the search engine market in China as it was in other markets around the world. 

 

Google was not the only US Internet giant that failed to achieve its goals in China, as Yahoo and EBay entered and exited as well.  Both used acquisitions of Chinese-based companies as part of their respective entry strategies, but Yahoo could not effectively compete with Baidu in the search market while eBay lost out to Taobao.com (owned by Alibaba) in the online auction market.  In both cases, both eBay and Yahoo did not do a good job in understanding the local China market nuances for search and on-line auctions. Yahoo at least made a financially smart decision to exit the market and invest in competitor Alibaba, which took over its Internet operations.  It is estimated by some analysts that Yahoo’s investment in Alibaba is worth 50% or much more of Yahoo’s current market capitalization. 

 

In all the cases above, US Internet companies stopped their efforts in China within about a five-year period.  While the Internet may move a rapid pace of innovation, business success in China, especially in the technology sector, takes a much longer-term commitment.  Google’s former CEO, Eric Schmidt, initially stated that China had 5,000 years of history and Google would have 5,000 years of patience in China.  As it turned out, Google, eBay and Yahoo only had about 5 years of loss-making patience.  Unfortunately for US Internet companies, China continues to grow much faster than the US in on-line sales and is likely to surpass the US within the next couple of years as evident by China “crushing” the on-lines sales record on November 11th, 2013 as part of China’s annual “Single’s Day” national promotion.

 

The concern over protecting IP and pirating software has been an obstacle for US technology companies seeking to expand their sales business operations in China.  Taking legal action by US technology companies has often backfired.  For example, Cisco Systems’ first-ever corporate lawsuit on IP was against Chinese based Huawei in 2003, which allegedly copied Cisco manuals and software code.  Cisco dropped the lawsuit in 2004 after remedy actions by Huawei, but in my view the lawsuit cost Cisco more in reputational risk than any benefit from the lawsuit.  To this day, China represents less than 5% of Cisco’s total sales in China and the company often highlights China as being “unique” for Cisco when discussing its sub-par performance in the country.  Microsoft has faced software piracy issues around Windows for PCs in China since the company entered the market in 1992.   The issue of piracy in China is still an issue today for Microsoft as evidenced from its recent earnings call where it disclosed for the first time the performance of its Windows business with and without China (i.e. Windows is declining more rapidly in China than the rest of the world).  Microsoft is hoping to reduce piracy of software by selling cloud-based versions of its consumer software, thus, hopefully eliminating over time the availability of pirated software disks sold on the streets.

 

Cisco’s problems in China have intensified recently as the company’s orders from China fell 18% in its recent October 2013 quarter. Cisco is likely feeling the backlash of Huawei’s years of struggle and ultimate failure in building a US business, which was exacerbated by recent press reports on spying by the US National Security Agency. Other large US technology companies like IBM and HP also reported recent weakness in China and Qualcomm has made public comments that U.S. restrictions on Chinese companies and revelations about surveillance by the NSA are impacting its business in China.  As a result of these and other recent data points, there is now a growing view on Wall Street that US tech firms are seeing slowing sales in China due to the NSA spying claims. It is interesting, however, that Franco-American company Alcatel-Lucent announced the day after Cisco report its poor China results that it had won the largest market share in China Mobile’s network for Enhanced Packet Core (EPC) technology among all vendors (including Chinese based vendors). Alcatel-Lucent sells in China through a joint venture established in 1984. Perhaps Alcatel-Lucent is not feeling the same issues as other large US technology firms because it is technically a French company, but it’s long standing JV and the relationships established by this JV in China also has likely played a role in its ability to so far overcome the political backlash that other large US technology companies have experienced.

 

While China based Internet companies like Baidu (search engine), Alibaba (e-commerce) and Tencent (social media and gaming), have generally become dominant in their home market, China based IT centric companies Huawei and Lenovo have established global businesses which have led to weakening fundamentals for Western suppliers of communications equipment and personal computers.  Huawei generated sales of $35.4 billion in 2012 and is now comparable in size to Western leaders Ericsson and Cisco.  The dramatic success of Huawei over the past fifteen years contributed to the bankruptcy of Nortel, the failed mergers of Alcatel with Lucent and Nokia with Siemens, and the lackluster stock performance of Ericsson and Cisco.  Lenovo became the world’s largest supplier of personal computers in 2Q13 with both IDC and Gartner estimating their market share at 16.7% surpassing both HP and Dell for the first time.  In 2009, Lenovo ranked fourth in the world in PC shipments with about 7% share.  While HP and Dell continue to suffer from the fundamental shift from PCs to tablets and smartphones, the loss of market share to Lenovo over the past few years intensified this fundamental issue for both companies and was likely a contributing factor to Dell deciding to go private through an LBO to realign the company and pursue a more Enterprise IT and Services strategy.

 

While US Internet companies and global IT equipment suppliers such as Microsoft, Cisco, HP and others have had either difficulties succeeding in the China market, or face significant competitive pressures from China based IT global competitors such as Huawei and Lenovo, there are examples of US technology companies that have succeeded in selling in China and competing globally against Chinese based competitors over an extended period of time and who so far, have not publicly acknowledged any political pressure on their respective businesses.  Two such companies are Apple and Corning.  Apple currently generates about 15% of total sales from Greater China and its operating margin in China is generally comparable with other regions.  This level of success has been achieved with Apple not yet selling iPhones to China Mobile, the largest mobile operator in the world based on subscribers.  Apple has also been vocal and active on improving working conditions in China among its supply chain companies including conducting annual audits on its suppliers; thus, thus likely helping its reputation in the country.  Corning has been in China for 25 years and competes effectively in catalytic converter substrates, LCD glass display and fiber optic cable.  The Greater China Region represents 26% of Corning total sales and is the company’s largest country by annual sales.  Corning attributes it success in China to having a very long-term perspective, developing relationships with key leaders at the local and national level on important issues such as IP protection, investing in local manufacturing and developing extra checks and balances on potential IP protection issues. 

 

While there is no magic formula for succeeding in the China market as a technology company, there are some common threads among companies that have shown success in the market.  These include, truly showing (not saying) a long-term commitment to the country, developing key relationships (including JVs) at the local and national level to help support a fair playing field and protection of IP, local manufacturing through long lived assets and R&D, understanding the risks of reputational damage when taking legal or other public action against a local company and enacting unique processes to help ensure IP is maintained.  Having products or a distribution of products that make pirating or copying of your products difficult, is also a big plus.

 

Note: The above article first appeared in the November 2013 issue of “The Cornerstone Journal of Sustainable Finance & BankingSM

 

Activist Investing In The Technology Sector

Recent earnings reports from technology powerhouses of the past couple of decades exemplify that these prior titans are all now challenged by lack of revenue growth, margin compression and/or disruptions from new technologies. In particular, Cisco, Dell, IBM, Intel, HP, Microsoft and Oracle all either suffered from weak revenue and/or margin results in their most recent respective earnings results.  Perhaps the confluence of weak results was coincident with the lack of global GDP growth and indicative that these large companies are all suffering from the “law of large numbers” as they have all become mature companies with exposure to legacy businesses (e.g. personal computers, Ethernet switching and structured relational databases etc.) that they all helped define and conquer in the prior three decades?  If true, however, the boards of these companies have to be cognizant of increasing shareholder activism in the technology industry and that more shareholder friendly actions in the form of increased capital returns to shareholders, potential company breakups and leadership changes will need to be considered in addition to traditional technology management actions such as using M&A to spur growth.   The fall from grace of HP prior to Meg Whitman being named CEO was unfortunately an example of a poor use of company cash for M&A, lack of internal investment for innovation and leadership selection choices and raises the question on whether an earlier action by an activist would have helped HP and its board make better decisions.

Recent successes of shareholder activism, which were not originally supported by company boards in large and “legacy” technology companies, have often led to favorable shareholder returns.  Such positive stock returns, will likely encourage further activism in my view from not only the traditional activists but from traditional “long only” investment funds.  The positive returns for shareholders in other “legacy” technology companies Motorola, Yahoo and Dell where activists became involved and ultimately led to a company breakup for Motorola, new leadership for Yahoo and a higher acquisition price for Dell in its planned LBO all resulted in favorable returns for shareholders.  Carl Icahn’s recent tweets regarding his recent investment in Apple, the largest technology company as measured by market capitalization, and discussions with Apple CEO Tim Cook regarding increasing capital returns for shareholders is further evidence of activism taking on the cash rich nature and relatively low valuation of large technology companies.

The recent case of Microsoft is also telling in regard to increased activism playing a role in leadership selection and potentially strategy change.  The fact that Microsoft is currently the third largest technology company in the world based on market capitalization, is not deterring activism from playing a role at this critical point in the company’s history.  In August of 2013, Microsoft offered a board seat to activist investor fund ValueAct Capital Management that had been pressing for a change of the CEO of company.  I also recall a few occasions during my career as a technology sell side analyst visiting institutional investor accounts around the same time as Steve Ballmer, CEO of Microsoft.  I found it interesting that investors would tell me how they made it a point to tell Mr. Ballmer that Microsoft needed to consider selling or exiting certain businesses, breaking up the company or other actions to enhance shareholder returns, but that such requests were falling on deaf ears.  When it was announced that Steve Ballmer would retire from Microsoft on August 23rd, Microsoft’s market capitalization rose by ~$20 billion.  After the announcement on September 2nd that Microsoft would acquire Nokia’s Device and Services business, thus doubling down on its current strategy even as a new CEO was not yet identified, Microsoft shares gave up about $13 billion in market capitalization.

Investors not only saw the Nokia acquisition as doubling down on the prior strategy, but at the time also the increased likelihood that Stephen Elop, current Nokia CEO and former executive at Microsoft, would be the next CEO of Microsoft and potentially maintain the status quo of Steve Ballmer’s tenure.  The opportunity to be heard and play a role in the future of Microsoft, however, was not going to be lost as shareholder activism led to several of Microsoft’s largest shareholders are putting pressure on the board of Microsoft to consider a CEO with “turn around” experience rather than someone who is going to just maintain the status quo.  It will certainly be interesting to see how the CEO selection of Microsoft develops and how activism will likely play a role in the CEP selection as well as the potential ongoing strategy post the selection.  The recent rally in Microsoft stock to a new 10 year high is a likely a sign that investors “smell” a positive leadership change, that will unlock value at the company.

Note: The basis for this article was originally published in the inaugural issue of the “Cornerstone Journal of Sustainable Finance and Banking” published in October 2013.

I also recently was interviewed on Bloomberg TV on the topic of Activism in The Technology Sector.  The interviewed can be viewed here

I Continue To Be Positive On Technology for 2013

Following up on my blog post in the beginning of the year, I continue to expect the technology sector to outperform the overall market (S&P 500) in 2013.  This opinion is based on three years of underperformance of the technology sector given a depressed level of telecom and enterprise capital spending which has compressed valuations for technology stocks vs. other sectors like consumer discretionary which as been a strong relative performer over that three year period.  I continue to believe we will have some recovery on capital spending in both telecom and enterprise networks in 2013, which together with lower relative valuations, should allow the technology sector to outperform in 2013.

So far in 2013, the technology sector is up around 4.5% vs. the 2.5% return of the S&P 500.  While it is still very early in the year, this initial outperformance and strong stock performance from IBM and Google (two large components in the technology sector index) today after their reporting their earnings (both are up about 5%-6% so far this morning) are very good signs.   The depressed level of technology stocks has also been supported by recent discussions in the press of Dell being a potential LBO candidate, and HP potentially being broken up to create shareholder value if the company does not show signs of a turnaround in 2013.

The biggest potential risk to technology outperforming in 2013 in my view is the performance of Apple as it makes up to 20% of technology index given its large market cap.  I am not particularly positive on Apple as it is losing momentum (see my prior blog post on Apple for more details) and does not play into the theme of recovering capital spending for technology stocks.  However, the stock has declined close to 30% off its high and is discounting many of the negative fundamentals I discussed in my earlier blog on the stock.

Disclosure:  I am currently not long or short any stock mentioned in this blog post (i.e. Apple, IBM, Google, Dell or HP).  I also do not plan on taking a position on any of these stocks in the next couple of days.  I am long the technology ETF ticker VGT.

Addendum – With the selloff in tech shares today 1/24/13, I am considering purchasing shares in technology stocks mentioned in this post.

Technology Sector Likely to Outperform S&P 500 in 2013

While the Information Technology sector had a reasonably good year in 2012 with a 14.0% return, the sector still underperformed the S&P 500, which returned 16.0%. In fact, the technology sector has underperformed the S&P 500 for three consecutive years.  While 2013 could prove to be another volatile year for the stock market given ongoing uncertainty on the global economy and the ultimate outcome regarding the U.S. fiscal cliff, I believe the three-year trend of underperformance of the technology sector will reverse, and the technology sector will likely outperform the S&P 500 in 2013.

In looking at the following table, one can see how in the past three years the consumer discretionary sector has been a consistent outperformer as compared to the S&P 500 while the technology sector has been an underperformer.  In fact, the consumer discretionary sector has been the best cumulative performer in the past three years among the ten market industry sectors.  One question is why has consumer discretionary outperformed the overall market while technology has underperformed for three straight years after the 2009 recession when normally both consumer discretionary and corporate capital spending recover nicely post a recession?

2012 2011 2010
Consumer Discretionary 24.6% 3.7% 30.6%
Information Technology 14.0% 0.5% 12.7%
S&P 500 16.0% 2.1% 15.1%

One could argue the outperformance of the consumer discretionary sector made some intuitive sense as the U.S. consumer started to gradually become more confident in 2010 post the 2008/2009 Great Recession and began to gradually spend more on discretionary items while at the same time taking advantage of record low interest rates to repair their personal balance sheets post the deb crisis.  On the other hand, corporate and telecom services capital spending growth have been lackluster in the past three years.   The ongoing economic slowdown and uncertainty in Europe combined with anxiety over U.S. economic/tax policy has led to cautious capital spending.  Thus, consumer discretionary spending has rebounded more strongly in the past three years and corporate/telecom capital spending.

While it is anyone’s guess how spending trends will fare in 2013, my view is corporate/telecom capital spending has underperformed for too many years relative to consumer discretionary spending and will show more robust growth in 2013.  We already have some encouraging signs in this regard by strong 2013 capital spending plans by major global telecom operators like AT&T, Deutsche Telekom and Sprint as examples.  I think this relative recovery in corporate/telecom spending will allow the technology sector to outperform in 2013.

The strong outperformance of consumer discretionary stocks relative to technology stocks in the past three years has also been evident when one looks at valuation metrics between the two sectors.   While valuation metrics like price/book and price/sales for the consumer discretionary sector have expanded nicely in the past three years, the same valuation metrics have actually contracted for the technology sector.  Thus, one could argue that the outperformance of the consumer discretionary sector was not only driven by better relative spending by consumers over corporates/telecoms, but also expansion of valuation metrics.  I think 2013 will be a catch up year for technology stocks in terms of valuation metrics, which should also help the technology sector outperform the S&P 500.

The table below shows the top eight stock holdings of the Vanguard Consumer Discretionary ETF (ticker VCR) and Information Technology ETF (ticker VGT).  The two tables below the list of stocks show how the valuation metrics for these 16 stocks have changed since the beginning of 2010 through the end of 2012 (i.e. over the three year period of underperformance of the information technology sector).

Consumer Discretionary (Ticker: VCR)

Information Technology (Ticker: VGT)

Comcast (CMCSA) Apple (AAPL)
Home Depot (HD) International Business Machines (IBM)
Amazon.com (AMZN) Microsoft (MSFT)
McDonalds (MCD) Google (GOOG)
Walt Disney (DIS) Oracle (ORCL)
News Corp. (NWSA) Qualcomm (QCOM)
Time Warner (TWX) Cisco Systems (CSCO)
Lowes Cos. (LOW) Intel (INTC)

 

Consumer Discretionary Valuation Metrics 12/31/09 vs. 12/31/12

Price/Book

12/31/2009

Price/Book

12/31/2012

Price/Sales

12/31/2009

Price/Sales

12/31/2012

Comcast 1.12 2.02 1.34 1.62
Home Depot 2.32 5.26 0.68 1.29
Amazon.com 11.08 15.02 2.38 1.98
McDonalds 4.80 6.41 2.96 3.24
Walt Disney 1.59 2.12 1.66 2.11
News Corp. 1.44 2.26 1.16 1.78
Time Warner 1.01 1.51 1.34 1.58
Lowes Cos. 1.49 2.85  0.64 0.79
AVG Increase

63%

28%

Information Technology Valuation Metrics 12/31/09 vs. 12/31/12

Price/Book

12/31/2009

Price/Book

12/31/2012

Price/Sales

12/31/2009

Price/Sales

12/31/2012

Apple 5.33 4.22 4.09 3.19
IBM 7.56 10.10 1.80 2.09
Microsoft 6.11 3.25 4.61 3.10
Google 5.46 3.4 8.32 4.87
Oracle 4.10 3.70 4.90 4.31
Qualcomm 3.62 3.14 7.33 5.51
Cisco 3.2 1.98 3.70 2.23
Intel 2.70 2.10 3.21 1.92
AVG Increase

-19%

-22%

In summary, technology has lagged the S&P 500 for the past three years while consumer discretionary has dramatically outperformed. In doing so, consumer discretionary valuation metrics have expanded dramatically, while technology valuations have contracted.  With the potential for a corporate/telecom capex recovery in 2013 and relatively low valuations, the technology sector is poised in my view to finally outperform the S&P 500 in 2013.

Has Apple Stock Peaked? Probably So

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:

  1. Fundamentals: Are the fundamentals accelerating or decelerating?
    1. Revenue Growth
    2. Margin Profile
    3. Market Share
  2. Sentiment: Is the stock over-owned or under-owned and is it loved/hated by the sell-side analysts
  3. Valuation: Is the stock expensive or inexpensive relative to the market and peers

Fundamentals Decelerating

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.