How Low Could Apple Go?

tim cook

Photo: Photo by Kevork Djansezian/Getty Images

Apple’s stock is now down about 30% from its high.

This plunge has led to a feisty argument between the Apple perma-fans, who dismiss the fall as “stock manipulation,” and other investors, who think that several fundamental trends that have made Apple the most valuable company in the world have started to change.

After defending the stock for the first few months of its swoon, meanwhile, Wall Street analysts are now rushing to cut price targets and downgrade it.

So, who’s right?

And how bad could it get?

Specifically, if those who believe Apple’s fortunes are changing are right, how low could the stock go? And might Apple’s stock just suddenly prove the doubters wrong and blast off to the stratosphere again?

Let’s address the broader question first.

Sorry, But It’s Not Just “Stock Manipulation”
I’m sorry to disappoint diehard Apple fans, but it is the height of reality distortion to believe that a 30% fall in the stock of the world’s most valuable company is just “stock manipulation.”

No one has the power to “manipulate” Apple’s stock to that extent. Apple is one of the most liquid stocks in the world. The folks who trade millions of shares of Apple stock every day are a highly diverse group of investors. Bad information can temporarily move stocks, yes, but the market is very good at sorting out whether new information is bad information or weak information and discounting it accordingly. So if, say, last week’s report that Apple had cut its iPhone orders in half was, in fact, inaccurate, the market has long since factored that possibility into the stock price.

Just because the market for Apple stock is liquid, of course, doesn’t mean that Apple’s stock price is “right.”

The market gets it wrong all the time.

But, importantly, the reason the market gets it wrong all the time is that stock prices are based on what people think will happen in the future, not what has happened in the past. And no one knows what will happen in the future.

In case you haven’t completely internalized that last paragraph, here it is again:

Stock prices represent a collective guess about what will happen in the future. And no one knows what will happen in the future.

The upshot of that is that Apple’s changing stock price is all about what the consensus thinks will happen to Apple’s fortunes and finances over the next few years.

And here, it seems clear, there are signs that several key fundamental trends that have driven Apple’s stock for the past decade are changing.

I’ve described these trends in detail here and here.

Here’s a summary:

  • The market for “premium” smartphones is maturing, and Apple does not offer a low-priced smartphone for emerging markets–which is where the explosive growth is. Thus, Apple’s growth will likely slow.
  • Apple’s competition has caught up in smartphones and is catching up in tablets (especially lower-priced tablets). Apple no longer has the market to itself.
  • Apple’s extraordinary profit margin will almost certainly decline as Apple sells more lower-margin tablets and, possibly, introduces a low-priced smartphone.
  • The TV business, which Apple is expected to enter, is a brutally competitive low-margin business, and Apple’s chances of revolutionizing this business seem low.
  • Recent management changes illustrate that the Steve Jobs era really is finally over, and the new regime has not yet demonstrated that it will be able to produce the same Jobs-ian magic.

It’s hard to imagine how a reasonable person could look at those trends and conclude that nothing has changed.

So it’s not surprising that Apple’s price-earnings “multiple” is compressing. That’s what happens when fundamental trends start to deteriorate.

With Apple now at $500, the key question is, what’s next?

Will Apple bounce right back and soar to the $1,000+ level that just about everyone was saying was a slam dunk four months ago?

Or will Apple keep falling? And, if so, how low will it go?

Well, importantly, no one knows. So don’t hallucinate that there’s some guru somewhere who can tell you.

For what it’s worth, here are my thoughts on this:

Call me crazy, but I actually don’t think Apple stock is going to collapse much further from here, at least not soon. The stock might drop to $400 or something–that would be normal volatility–but I don’t see it crashing to say, $200, unless something radically changes.

Meanwhile, I think there’s a good chance that Apple will continue to grow over the next few years, albeit at a slower pace than it has grown over the past few years. And this, I would guess, would leave the stock trading in a range of about $400-$700 for a few years.

Specifically, fundamentally, I think the following things will happen over the next few years:

  • Apple’s revenue growth will slow
  • Apple will be forced to offer a low-price smartphone
  • Apple will be forced to offer lower-priced tablets
  • Apple will launch other new products but none will be world-changing mega-profit hits like the iPhone
  • Apple’s profit margin, which is currently an absolutely astounding 26%, will decline
  • Apple’s earnings growth will slow or even decline as Apple’s profit margin drops
  • Apple will continue to be an excellent and healthy company

The most important theory here from a stock perspective is the belief that Apple’s earnings growth will slow, stop, or even decline.

This theory is based on the following assumptions:

  • Apple’s revenue will grow, but
  • Apple’s profit margin will decline

Let’s put some numbers on that.

In the last fiscal year, Apple generated $157 billion of revenue and $42 billion of profit (26% profit margin).

Let’s say that, in a couple of years, Apple’s revenue grows to $250 billion, but its profit margin declines to 20%. In that scenario, Apple would earn $50 billion in a couple of years. That would be nice earnings growth, but it would be a major slowdown over the last few years.

More optimistically, we could say that Apple’s revenue might grow to $250 billion but that the company could somehow maintains its profit margin. Then the company would earn $65 billion in a couple of years. That’s a lot more than $50 billion.

More pessimistically, we could say that Apple’s run as the smartphone and tablet champ really is over and that Apple will fail to introduce cool new products and a low-priced smartphone and that its revenue will only grow to $200 billion (or less) and its profit margin will shrink to 20% (or less). This would produce only $40 billion of profit–less than the company is earning now.

All of those scenarios, in my opinion, are reasonable. I don’t know which will actually happen. But I think the most likely scenario is the first one I laid out… revenue deceleration and margin declines, all of which will lead to stock multiple compression.

The good news is that Apple’s stock multiple has already compressed. The stock is now trading at 11-times trailing earnings.

That is just not a high price for a company of this quality and promise.

It’s not a screamingly cheap price, either–plenty of companies trade for a lot lower than that–but it’s not expensive.

But it’s a price that suggests that, unless something terrible happens, the stock probably won’t completely collapse from here.

Of course, there’s always the chance that something terrible will happen.

The Armageddon Scenario
One thing that’s important to remember when you’re thinking about a company and stock like Apple is that amazing stock stories don’t go from great to awful overnight.

The stories about massive “must-own” stocks that make investors a fortune over many years, only to then collapse and lose almost all of their value over the following several years, are legion.

In hindsight, these “round trips” seem obvious:

When the stock hit its peak, the 20-20 hindsight goes, any fool could have seen that it was going to completely collapse.

The reality, not surprisingly, is different.

A light doesn’t suddenly just change from green to red.

Rather, something small changes, and the stock drops a bit. At first, everyone regards the drop as a “buying opportunity,” just like all of the temporary drops of the past several years. Then something else changes, and the stock drops some more. This time, some people start to observe that something has changed. But most people still regard the fall as a buying opportunity. Then more things start to go wrong, and the stock drops some more. Now, everyone knows that things have changed, but the stock price has also dropped, so it doesn’t seem to make sense to sell at the lower price–better to wait until the stock comes back a bit. Then more things go wrong. And the stock falls some more. And so on. Eventually, years after the peak, the company is a mess, and the stock is flat on its back, and everyone who didn’t sell feels like an absolutely moron. But, importantly, at every step along the way, the stock was trading at a level that likely seemed reasonable relatively to a reasonable range of scenarios about the future. So the mistakes really are only obvious in hindsight.

I made that mistake with Yahoo in the 1990s. I thought that Yahoo would be one of the long-term dotcom winners–a must-own stock for the digital generation.

I was willing to accept a lot of volatility, because I was a long term investor.

So when Yahoo first collapsed, I didn’t really mind.

But then, over the years, the industry changed, and Yahoo fell farther and farther behind.

Now, 15 years later, I own a $20 stock that once traded as high as $108. And I feel like a moron.

(True, it could have been much worse. Yahoo could be a $0 stock).

Of course, lest you think the moral of that story is “sell at the first sign of trouble!”, I also thought that Amazon would be one of the big winners of the digital generation. So I bought and held that stock. Like Yahoo, when the dotcom bubble burst, Amazon collapsed. But, unlike Yahoo, Amazon eventually came back–and then some. My Amazon perseverance, in other words, has paid off–I have gotten a perfectly good return on my investment. My Yahoo perseverance, meanwhile, cost me my shirt.

So, the truth is you just never know.

And the point about Apple is this:

It may be that the new Apple will be just as astounding a company as the old Apple–that all the Apple doubters will soon be shamed and the stock will blast off to the moon again. That’s certainly possible.

And it’s possible that Apple will go through a multi-year period of “consolidation,” in which the stock trades sideways in a big trading range. Google did that for years. Amazon did that for years. Microsoft has done that for 12 years. All of those stocks were “must-own” story stocks in their day. It happens all the time.

But it’s also possible, I am sorry to say, that Apple is in the first stages of a Yahoo-like decline.

When Apple collapsed the first time, you will recall, back in the 1990s, Apple didn’t go from “top of the world” to near bankruptcy overnight. The collapse took years. It included the hiring of John Sculley. Then the firing of Steve Jobs. Then the firing of John Sculley and the hiring of Gil Amelio. And a bunch of dud products. In other words, it was a long, gradual decline.

The same thing could be happening to Apple right now.

I don’t think that will happen. I hope that doesn’t happen. But to argue that it can’t happen would be to stuff your head in the sand.

Apple’s markets are changing. Apple’s management is changing.  Apple’s products are changing, Apple’s culture is changing.

No one knows for sure yet where those changes will lead.

But for the must-own “story stock” of past decade, the next few years are going to be interesting.

SEE ALSO: It’s Official: Apple Has Lost Its Edge

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