The market got clobbered yesterday, and so did Apple.
Apple’s stock closed at $419.85–its lowest closing price since its slide from $700 began last September.
Apple is now down 40% from its peak.
And anyone who has bought Apple in the past year and held it has lost money on it.
What’s going on with Apple’s stock? How low could it go? When might we see a bottom?
On the first question, there are several things going on with Apple’s stock. I’ll discuss them in detail below.
On the second question, the answer is, “probably not much lower…unless the business takes another turn for the worse.” And, unfortunately, it is quite possible that the business could take another turn for the worse, if not several more turns. (Companies don’t go from spectacularly healthy to moribund overnight–the process usually takes years.)
On the third question–when might we see a bottom–there’s a chance that we could hit at least a temporary one soon.
For the last couple of months, Wall Street has been dreading Apple’s first quarter earnings report. The prevailing theory is that Apple will not only report a lousy quarter, but will also offer guidance for the second calendar quarter that is well below Wall Street’s current estimates. The hope among some Wall Street bulls is that this double-whammy of bad news will reduce expectations for the company just as anticipation begins to build about the summer and fall launch of several new products. This combination, the theory goes, could put in a bottom for the stock.
Of course, if Apple’s swoon over the past six months is the start of a long-term decline, this respite will likely be short-lived.
What Has Gone Wrong?
Some of the issues plaguing Apple’s stock are fundamental, having to do with changes in Apple’s business.
Others are related to sentiment and changes in Apple’s shareholder base (“Momentum” and “growth” investors are continuing to dump the stock, on the theory that Apple’s growth days are over. And as they dump it, the only folks willing to buy it are “value” investors who care deeply about price).
Here are some of the things investors are concerned about:
- First, Apple’s earnings are no longer growing. On the contrary, this quarter, Apple’s earnings are expected to shrink year over year. Investors don’t pay a lot for the stocks of companies where earnings are shrinking.
- Second, several reports have suggested that orders for Apple’s key product, the iPhone, will be weak this quarter and next quarter. Late last year, for example, according to UBS and other sources, Apple cut its “build” orders for iPhone 5s from 35-40 million units to 25-30 million. There were reports last quarter that iPhone 5 sales were decelerating faster than expected and that Foxconn, Apple’s iPhone assembler, had frozen hiring. All this suggests that sales of the all-important iPhone may be far lower than Wall Street has been expecting–not just this quarter but next quarter.
- Apple refreshed its entire product line last fall, and we’re still in the middle of a new-product blackout period. Analysts were expecting that we would get something new from Apple in March, but we didn’t. The next iPhone, meanwhile, isn’t expected until at least June, and it is likely to be a boring minor upgrade to the already underwhelming iPhone 5. (In the meantime, Samsung will have launched its new Galaxy S4). Later this year, we’ll probably also get a new iPad Mini, but that won’t be terribly exciting, either. The only potential for real excitement is a blockbuster new smartwatch (iWatch) and/or an amazing new Apple TV. But the latter has been expected for two years now, and it’s not clear whether Apple really has a chance to do anything revolutionary or cool here.
- Apple’s amazingly high profit margin is declining and is likely to continue to decline over the next several years. This is happening because Apple’s product mix is shifting toward lower-margin tablets from the high-margin iPhone, as well as because the iPhone margin itself is declining with the introduction of lower-priced phones. This suggests that Apple’s earnings are likely to grow more slowly than revenue over the next couple of years, in contrast to the situation for the past 5 years.
- One of Apple’s next revolutionary new products–a TV or TV device of some sort–always seems to be about a year away, with the expected date of release perpetually getting pushed farther into the future. Analysts are also not sure what this product will be and how it will sell. Dozens of companies have tried to reinvent TV over the last 15 years, and almost all have failed. Apple also appears to have met resistance from the TV content and distribution industry, which will do everything it can to preserve the status quo. The timing of Apple’s other expected revolutionary new product, a smartwatch (iWatch), is also still uncertain, and it’s not clear whether consumers will actually see a need for this product. The iWatch is also likely to be relatively low-priced ($99? $199?), so the company would have to sell a boatload of them to really move the needle.
- The smartphone market, which has driven Apple’s spectacular iPhone sales over the past 5 years, has entered a new phase, in which low-priced phones are capturing most of the market share. Apple does not yet offer a low-priced phone, so it is missing out on this growth. If Apple does release a new cheap iPhone this year, as is widely expected, this will likely add to the pressure on Apple’s profit margin.
- Apple’s competitors have caught up in smartphones and tablets (and now, possibly, in prospective TVs and watches), so Apple no longer has the leverage with distributors and consumers that it once did. Samsung and Google in particular are stealing much of Apple’s thunder (and potential customers). This, too, could eventually lead to more margin pressure, as Apple is forced to cut prices to remain competitive. Apple recently had to do this with a new Mac.
- Lastly, Apple really has finally entered the “post-Steve Jobs” era, and it remains to be seen how successful the company’s next generation of leaders and products will be. One Apple observer, Paul Kedrosky, recently blamed Apple’s inability to meet demand for its new Macs on a culture in which no one will say “no” to Apple’s design teams. Others dispute this, but the broader question is whether Apple’s leadership team will be able to drive the company forward smoothly and aggressively without Steve Jobs.
All of these factors are weighing on Apple’s stock.
But here’s the good news:
The stock is now cheap.
Apple is now trading at 10X trailing earnings per share.
Apple could certainly get “cheaper,” especially if its earnings continue to decline. The stocks of companies that are truly troubled, like Dell, BlackBerry, and HP, often trade at mid-single-digit PEs. (See: “How Low Could Apple Go?“) But for now, at least, Apple is still healthy, so if Apple ever gets to, say, 8X earnings, it will be screamingly cheap.
At 10X earnings, Apple is just cheap–cheaper, for example, than the stock market as a whole. And Apple also has nearly $150 billion of cash.
What will Apple’s stock do from here?
No one knows, so don’t get fooled into thinking that there’s some guru out there who can tell you definitively.
Apple may release some exciting new products later this year that will get investors buzzing and cause them to pay, say, 14X for Apple’s earnings instead of 10X. And that will produce a nice jump in the stock.
Or Apple may be in the early innings of a long secular decline in which it eventually becomes the equivalent of Dell (or, worse, Nokia. Or Digital Equipment Corporation.) That depressing future is entirely possible, so don’t delude yourself into thinking that it isn’t.
One thing we can say, though, is that, at 10X earnings, Apple looks cheap and is still in robust financial health. That means that even modest unexpected good news may drive the stock significantly higher.
(I don’t buy individual stocks these days, but if Apple were to double its dividend to a 4%+ yield, I might find that irresistible. Even if Apple is in the midst of a secular decline, it will likely be able to keep paying those dividends for a good long time.)
SEE ALSO: How Low Could Apple Go?