Apple analysis as of 2/23/15

Contrarian

I have been contrarian several times and most times I made good money. We need to have good arguments to be contrary. Otherwise, we’re committing financial suicide.

Many investors commit the same error: Invest in a company because they love the company’s products. We need to check in the fundamentals of the company and its prospect. I have nothing against Apple. Actually I recommended Apple before based on its great fundamentals while everyone was dumping it. Where were today’s enthusiastic analysts?

 

Scoring Apple

When I was writing the book Scoring Stocks, first I used IBM but its low score would not be a good example. Then I switched to Apple (AAPL). It scored almost the highest. I recommended AAPL at $55.72 (split adjusted) on April 19, 2013, the date the book was published. It is another example that fundamentals work. However, when we’re swimming against the tide, we need to be patient. At that time, the media and institution investors ignored fundamentals. The best argument of not buying Apple was “Apple has turned from a growth stock to a value stock”. They think they cannot get fired by thinking the same as the herd. Just garbage talk from the smartest folks!

Fundamental analysis as of 02/23/2015

	Passing grade	AAPL		Industry
Score System  #1	>=15	16
Score System  #2	>=2	2
Pow EY	>=5	6%
Expected Earning Yield	>5 & <35 span="">	7%		5%
Debt / Equity	<.5	.30		.29
Analyst Rating	>7	9
EB/EBIT	>5	13
F-Score	>7	6
ROE	>=15%	37%		27%
SMA-200%	>0%	29%
RSI(14)	<60 span="">	78
Price		$132.06

Explanation

Ø  The first scoring system incorporates many vendors’ grades. The second scoring system is from my book Scoring Stocks using metrics available free from many web sites.

Ø  Pow EY – Earning Yield (E/P) takes cash and debt into consideration.

Ø  Expected EY, Debt/Equity, ROE, SMA-200% and RSI(14) are obtained from finviz.com.

Ø  Analyst Rating is from Fidelity. If Fidelity is not your broker, use Recommendation from finviz.com.

Ø  EB/EBIT and F-Score are from GuruFocus.com.

How Apple scores

It scores fine but not spectacular. The score from my book in April, 2013 is 5 and now it is 2. Fundamentally it is not as good as before.

P/B and P/S are usually not useful for high tech companies. However, Apple’s P/B at 6 is exceedingly expensive as compared to Google’s 3. When most analysts like the stock, usually it will rise in the short-term. RSI(14) shows it is overbought. To conclude, its fundamental score passes but not in flying colors.

The brief Fundamental Analysis should be followed by the following:

Intangible Analysis (described next).

Qualitative Analysis includes articles for Apple. First, start looking for articles in Seeking Alpha. Large companies like Apple are hard to manipulate, so most articles are not ‘pump and dump’.

Technical Analysis detects the trend and overbought condition. Many investors do not buy a stock that is in its downward trend. SMA-200 is a good trend indicator. Its price should be above the SMA-200 (same as SMA-200% is positive).

Intangible Analysis

Apple has lost a visionary leader Steve Jobs. I hope he was not replaced by similar managers at Microsoft, who are responsible for Microsoft's lost decade with few innovative products. Apple has a lot of cash to finance new projects. High tech business is tough as they need to build a better mouse trap continuously. When the mouse trap becomes a commodity, it will not have a good profit margin. That’s one reason that Buffett does not invest in Apple.

There are bright spots and bad spots for Apple:

1.       Apple Text Book. Imagine all students carry iPads instead of text books. Several educational apps have been created for iPads.

2.       Apple TV.

It is a loser so far with a lot of risk and potential competitors. However, the potential is great. It could give all cable companies a run for the money. Wider internet channels would make it more feasible. Will the cable companies provide these speeds to allow Apple TV and similar products to step into their turfs?

3.       While the iPad and iPhone are peaking in the hardware, iTune, software and contents for these devices to access have no limit. We have witnessed how iPad helps the folks with autism and iPhones for the blind. I can envision many other similar applications.

4.       Apple moves to Kindle's market. The standard iPad is too big to be used to read books during commute. You need to hold an iPad with both hands. The mini iPad, even making fewer profit margins, will be Apple’s answer to Kindle and a good addition to cover the lower end of its product lines.

5.       All the mobile phone technology is originated by the first generation (if not counting Motorola) that Apple has a lot of patents. Its lawyers will milk money from Samsung and prevent cheap mobile phones from coming to the USA.

6.       Apple Pay.

I saw a similar ad from a credit card company a while ago and not recently. Apple has a proven history of picking up some failed products and turning them into gold. It is a big test for Tim Cook. Hong Kong had a similar application many years ago but its card does not need battery. The advantage of that application is you do not have to carry changes. In the current form, Apple Pay will not make a big splash in Apple’s bottom line.

7.       Apple iWear/iWatch.

There will be cheap Chinese products flooded in our market. However, the selling point is the prestige of Apple. For a similar reason, my $50 Casino has no respect even it is more accurate and more functional than an Omega costing many times more. The major problem of iWatch is the short battery life. If you have to charge it one or even two times a day, it will not be too useful. Only social climbers would buy the $4,000 that does not function as a $10 watch. The other problem is how secured the data.

8.       Apple has a lot of cash. Dividends usually boost the stock price and the option values granted to the management. However, it is important to plow back to development and acquiring technologies. They may have paid too much for Beats.

9.       The major worry is whether they can maintain the urge of upgrade. If the new enhancements would not give me reason to upgrade, I would not be the one waiting in long line in bitter cold weather to upgrade my iPhone just for my dumb ego. It accounts the majority of Apple’s profit.

The other risks are the competition from Samsung and a little-known company Xiaomi. 

Xiaomi, a Chinese phone maker, will most likely come to the USA in 2016 after conquering several emerging markets. Its phone is almost as good as the latest model of iPhone at about half the price. It also has a low-end version priced at about $100 that would set up a standard for entry smart phones.

Xiaomi prices the latest phone model barely above the manufacturing price and makes money in the decreasing component prices. It gains more profit by stretching the model to a longer life.

Apple’s lawyer will prevent its entry that Samsung found out the hard way. For starters, Xiaomi needs to modify the user interface to avoid some of the obvious lawsuits in the USA.

When the phone becomes a commodity, both companies have to make money in the content. Today Apple depends on iPhone for over 50% of its sales. After 2016, Apple may face some challenges. Eventually the smart phones may become a commodity product. Xiaomi have to fix a lot of problems before they can sell their products in the USA. This is similar to what Lee Lacocca said about Hyundai: When they fix their problems, we'll be in big trouble.

While the fundamentals are still great, I predict the stock will not increase at this pace. In 2016 or Apple problems surface, I predict Apple’s stock will face real challenges. Will there be another miracle? I do not bet on it as Tim Cook is no Steve Jobs.