Apple Inc. (NASDAQ:AAPL) announced earnings on Thursday after its stock price skyrocketed during the pandemic. As the most prominent stock among retail investors, Apple’s financial success in its Q3 fiscal quarter earnings will be an important litmus test for whether the pandemic bull market was real or just a temporary high driven by government borrowing and fiscal stimulus. Apple appeared indestructible until late fall, but investors are beginning to challenge the status quo rather than take it at face value.
AAPL is currently trading at $154, marking the third significant increase in the last six months. But every time this has happened, the stock has dropped back to where it started and set a new low.
Is Apple Well Financially Posited?
Yes, but can the current rate be sustained?
During the pandemic, Apple did exceptionally well financially. Consumers were stranded at home and received substantial stimulus, directing spending toward products, particularly technology. Apple managed the supply chain very efficiently and maintained its items in stock significantly better than its competitors.
However, as consumer spending switches from products to services such as travel, dining out, and live entertainment, it’s unclear whether this pace will be maintained. For example, the used-car market is severely out of whack, and buyers who don’t want to deal with the supply chain and ongoing concerns like chip shortages appear content to direct their purchasing to less impacted areas.
Does AAPL’s Valuation Make Sense?
Not really.
When assessing a company that has increased significantly in price over the last few years, a fundamental test is to determine whether the price increase was primarily driven by earnings (business performance) or if the multiple investors are ready to pay has increased (speculation). Stocks can sometimes change the narrative and find new methods to grow, resulting in a higher multiple. More often than not, investors and sell-side analysts fall in love with stocks and overpay for them.
The multiple of AAPL increased from roughly 10x seven years ago to more than 30x during the pandemic! This suggests that their stock price growth has far outpaced their business achievements. Analysts argue that AAPL revolutionized everything by generating service revenue, but I believe this is far overstated.
However, as you go deeper into the services narrative, you find that antitrust difficulties will severely hamper future service expansion. Google now pays Apple just under $20 billion per year to be the default search engine in Safari. According to my calculations, that’s approximately 20% of AAPL’s net income from one client, who happens to be another large tech business less than a 20-minute drive away!
Apple’s services business is a tremendous profit center, but it isn’t going to double every 3-4 years in the future. As the antitrust enforcement environment heats up, their service revenue might stagnate.
Will Apple Beat Its Quarter Earnings?
For the fiscal quarter? Probably. However, the future outlook is far murkier.
On Thursday, Apple is likely to disclose $1.15 in quarterly earnings. This estimate, like almost all tech companies, is slightly sandbagged. Thus AAPL should announce a “beat” of at least 2-3 cents. But the more intriguing question is what will happen in 6-12 months. Since the pandemic, Apple has refused to provide profit guidance. This, I feel, is a big mistake because it eliminates transparency from the market and causes individual investors to chase hysteria and hype.
According to Wall Street analysts, an earnings growth of 9% is expected in the fiscal year 2022, 6% in the fiscal year 2023, and 4% in the fiscal year 2024. Given that AAPL is currently selling at 25x earnings, this doesn’t provide much of a margin of safety. There are numerous disconnects with Apple stock, but this is one of the more significant ones. The amazing thing about Apple was that the stock was still relatively inexpensive despite how much the company had grown over time. When AAPL stock doubled in the summer/fall of 2019, this all changed and accelerated into the epidemic. Earnings climbed 2x, but the stock increased more than 4x, implying that some genuine business success was hyped up.
What Is Apple’s Long-Term Outlook?
In the long run, AAPL should be OK. However, I believe you are overpaying if you buy the stock now. Earnings are at a cyclical peak and are anticipated to fall; when this happens, the multiple will need to return to its historical range.
This isn’t an exact science, but a 20% drop in earnings to $5 or so and a 20% drop in the PE multiple to around 20x indicates a price target of roughly $100 for AAPL. On the negative, the pendulum tends to swing the other way, and I wouldn’t be surprised to see this stock at $80 if the enthusiasm dissipates (note that AAPL would be nicely undervalued at that price).
If you have a long-time horizon, I believe you will profit from AAPL. However, the current price does not make sense. You’re looking at a total return of approximately 5-6% per year if you buy now, which is less than the market as a whole and far less than you could make if you were prepared to spend the time to research the financials of the firms you invest in.
Is Apple Stock A Buy, Sell, Or Hold?
AAPL is a sell, in my opinion.
This has been an unusually volatile week for stocks. The Fed meets on Wednesday at 2:00 PM Eastern, just before a slew of Big Tech earnings, including Microsoft (MSFT), Amazon (AMZN), and Apple.
So far, the stock market decline has resulted from market participants cutting stock multiples rather than analysts lowering profit expectations. If the present crop of Big Tech companies’ earnings proves to be cyclical in the end and they cannot raise EPS at double-digit compound annual rates in the future, the market would suffer greatly. Look at the disparity between discount rates and Bridgewater earnings from a few weeks ago—something has to give.
Featured Image: Megapixl @Lester69
