A steep stock market decline such as we experienced over the final three months of 2018 generally takes no prisoners, spreading devastation unmercifully across stocks in all sectors. Considering its recent crowning as the most valuable company in the world, the stock price decline of Apple (NASDAQ: AAPL) has to be one of the most epic. Yet, it wasn’t even the largest decline for Apple in percentage terms during the iPhone era. Apple has had similar price declines several times since the introduction of the immensely successful iPhone.
The conventional wisdom is now telling us that the company has entered a new era of slowing iPhone sales, which has fundamentally changed its once enviable revenue and earnings trajectory. However, the question one has to ask is whether the company’s valuation, even at a market capitalization of over $1 trillion, is even accurate. Is it possible that, after its nearly 40% sell-off, Apple presents an historic buying opportunity?
Just How Epic Was Apple’s Stock Decline?
For some perspective on just how epic Apple’s stock decline was, at its recent low of $142 a share its market cap had shed about $446 billion, which is larger than the individual values of nearly all of the other companies in the S&P 500 index. But, when considered against the backdrop of one of the strongest stock performances over the last decade, one has to wonder whether the decline was a precipitous overreaction or are Apple’s days as an iconic market leader truly over.
Adding fuel to its own fire, Apple announced in December that it expects lower revenue and earnings precipitated by a cut in iPhone production. The announcement drove Apple stock down another 10% in one day. Citing the trade war and China’s weakening economy, Apple CEO Tim Cook gave no indication of a turnaround in iPhone sales, which analysts took as further justification for lowering Apple’s stock price projections.
Did the Market Overreact on the Upside or the Downside?
But what if Apple’s stock price at its peak ($232 on Oct 3, 2018) was justified; that it wasn’t overvalued and its current price ($155 on Jan 16, 2019) doesn’t reflect its true market potential? What if the market isn’t looking at Apple in the proper context – as a device manufacturer gradually transitioning into a global services business? Now that the market has beaten the stock down for missing expectations on device sales, is it possible that Apple is actually a superb value play for the growing recurring revenue its services business is generating?
Considering that Apple is sitting on a base of more than 750 million active iPhone users with nearly half entering an upgrade window over the next year or two; and that it is also sitting on $130 billion of net cash, investors and analysts may have been a bit hasty in their condemnation of Apple. Not to mention that its services business, with steady revenue growth of 26%, is valued at around $400 billion on its own.
One only has to look at the success of Microsoft (NASDAQ:MSFT) after it began to focus on its software-as-a-service business model. It’s stock price has more than doubled since then its market cap is slightly larger than Apple’s (after the fall). The market likes those recurring revenues, and it may think even more of Apple’s revenues from services when it reaches $100 billion annually, which it is expected to do at its current growth rate.
Certainly, Apple will need to overcome some serious challenges in the coming years and refocus its efforts on geographical expansion and breakthrough technologies that will entice iPhone users to upgrade. And, it is certainly aware that investors are looking beyond devices to see if Apple continues to be the innovator everyone has come to expect.
Does the Market Know How to Value Apple Stock?
Now consider that, as a technology company, Apple has always had lower valuations than other companies in the sector. It’s Price-Earning (PE) ratio has always been lower than its closest peers. Apple’s PE at its recent peak was 19.02 as compared with Microsoft at 47.46 and Alphabet (NASDQ:GOOG) 45.41. As of Jan 17, 2019, Apple’s PE now sits at 12.77, which is lower than the tech sector (28.03) and even the S&P 500 (20.11). All of this suggests a much more conservative valuation for a market stalwart like Apple.
By most measures, a company with Apple’s low PE, dominant market position, strong cash position and relative earnings strength, is considered undervalued. Using Touchstone Capital’s three valuation models, we find Apple stock to be selling at a discount of between 26 and 48%. In the final analysis, Apple’s stock did not overshoot on the upside, and the sell-off looks to be unwarranted.
Apple Price Drop Creates Historic Opportunity
Apple has never been a conventional technology company, and the stock price has never been valued that way. The stock’s device-oriented sales were seen by investors as a vulnerability that constrained its valuation. Now that the company is transitioning to a cloud-based service model, the company deserves a second look through the lenses of an emerging technology company with a reliable and growing stream of revenue and earnings. Thus, the recent drop may have created an opportunity to buy one of America’s great companies at an attractive price.
