Apple is the most valuable publicly held company in
the world, with a market capitalization of $652 billion as of today. Its huge success is well deserved, as more
than any consumer goods producer, AAPL offers products that combine high
quality, style and ease of use.
Furthermore, AAPL has had the foresight to secure software and hardware
design and ownership and to integrate services and devices as it famously did
with iTunes.
There is no argument that Apple is a global success story
and that the company has gone from success to success first with its Macs, then
the iPods, iPhones and iPads. The
question is whether the stock is a buy at current levels.
As someone who bought the stocks years ago at $14 to
sell it for a quick $10 gain a few months later, and who felt he had been very
astute, I am not be the best judge of the company’s prospects. But I do have a view, which is that the
critical factor is the gross margin.
Most analysts argue that the stock is cheap because
it sells at a p/e multiple of 16.2 times trailing 12 months earnings. This p/e multiple is further lowered to 13.4
if we deduct from the market capitalization the value of the excess liquidity[1]. That is true, but this “cheapness” is due to
a very high gross margin. This margin
reached 44.1% for the last trailing 12 months, vs. 40.5% in 2011 and 29.1% in
2006.
One could point to IBM which achieved an even higher
gross margin of 46.9% in 2011. The
difference is that IBM’s business is more stable, being based mostly on
services; IBM’s gross margin was 41.9% in 2006, not so different from today.
Unlike IBM, Apple relies essentially on one product,
the iPhone, for about 65% of its gross profits with the Mac, the iPod and the
iPad for roughly 12% each. The iPad may
bring some added diversification, but time will tell.
While Apple was a pioneer with the iPod, iPhone and
iPad, competition is now heating up with giant electronics firms such as
Samsung and Google invading its turf with ever more performing products. This is not a setting conducive to fat
margins.
Another factor to take into account is that Apple’s
products are expensive; I suspect that the penetration of Apple’s products
among the middle and upper socio-economic strata is pretty high. Apple’s share of smart phones is estimated at
38% in North America, 26% in Western Europe, 25% in Japan and 20% in Asia[2]. One would think that to gain greater market
share, Apple would have to target lower income buyers, which is not compatible with
selling expensive, high margin products.
So what if Apple’s gross margin were to revert to
its 29.1% level of 2006, everything else being equal? The p/e multiple would rise to 27.7, and 23
after deduction of excess liquidity.
Quite a different picture, although one that may be unrealistically
bleak; after all, even if winning greater
market share likely necessitates selling lower price and margin products,
replacement devices for higher-end customers would probably remain very profitable.
Since I don’t know how long such a margin erosion might
take nor its extent, and since, in any case, the future is always uncertain, I
will take the average of current and estimated p/e multiples after deduction of
excess liquidity. I get 18.2. This is not excessive, but neither a bargain
nor a sure win. This assumes that Apple’s
excess liquidity of more than $110 billion will be either distributed to
shareholders or wisely invested. Finally,
for reference sake, let us note that Samsung Electronics shares trade at a p/e
multiple of 14.9 on the same 12 month trailing profits and ex-liquidity.
In sum, I think that investors who consider buying
Apple shares shouldn’t focus on the low p/e multiple but on the high gross margin.
[1] Defined
as cash and bond holdings. We consider
that 2% of the average of sales for 2011 and estimated sales for 2012 is used
in the business and therefore doesn’t qualify as excess liquidity.
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