And now you start buying AAPL

At around 600 USD, I thought AAPL was starting to be priced to perfection and that there would be no reason to try to time the highs. Turns out, AAPL hit 705 USD, level that was just little out there, and then tanked down to 419 USD. In the meanwhile net profits rose to 41.7 billion and cash pile to 137 billion. The ex-cash market cap has approximately halved, but they are doing a bit better than I thought.

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I think it is time to buy AAPL.

The math looks as follows. At current 428 USD per share, we have 402 billion market cap, which drops to 265 billion excluding cash. At 41.7 billion in net profits, P/E is down to mouthwatering 6.35, a really pessimistic figure. It seems to me the investing public is expecting Apple’s bottom line to halve from its current level. Personally, I am expecting to see bottom line at least in excess of 35 billion this year and possibly record profits next year with the economy turning the corner, not to even mention the nominal figures that tend to get a boost from money sloshing around endlessly, and Apple certainly has the competence to turn top line into bottom line.

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It’s time to downgrade AAPL

While I have been overtly positive on AAPL over the last year, the stock has reached heights that no longer offer much upside given reasonable assumptions.

At 593 USD a share, Apple’s market cap is at 553 billion dollars. The stock saw its highs few days ago at over 600 dollars. I am not at all convinced there is a case for investing into AAPL at 600 USD. And since no investors buys a stock based on the idea that it is not worth more than what it is currently, let’s assume that one is seeing Apple at 10 per cent higher.

This leaves us with a target market cap of 615 billion dollars.

The rolling 4-quarter net income is 32.982 billion dollars.

On top of this, the company has 10 billion in cash, almost 20 billion in short-term investments and over 67 billion in long-term investments for a grand total of 97.6 billion in non-operational assets.

This leaves us with roughly 517 billion ex-non-operational assets market cap supported by just short of 33 billion in annual net income.

This translates into a P/E ratio of 15.7, which in itself is not outrageous. SP500 as a whole is trading around 12 P/E on a forward earnings basis. While longer-term averages are higher than 12, such levels would not be consistent with current environment.

For the company to have a P/E of 13 it would have to raise its earnings from 33 billion to 39.8 billion.

Now, perhaps at some point it became reasonable to assume that raising your bottom line by about 7 billion is nothing, which incidentally means raising your pre-tax profit by about 10.8 billion at 35% tax rate, but it is quite a feat. But the problem is that for these valuations to be reasonable Apple would have to retain aforementioned profits forever and while it might be the case that nominal GDPs will continue to grow far into the future, the far more important notion is that Apple’s valuation forces you to assume that computing as an industry does not change much and that Apple will be able to retain its incredible share of smartphone and tablet profits forever.

I don’t have doubts about Apple’s ability to retain high level of operational excellence, carry its day-to-day operations without major hick-ups, create persuading marketing and maneuver in the industry mostly ahead of the curve, but I don’t believe the company would be able to deliver nearly at the current level of profitability if computing and thus the most profitable business models would change markedly in the next 5 to 10 years. I also do not believe they that are able to grow meaningfully from where they are as of now without compromising profitability, and that is what counts. If profits level, valuations will come down. They are not infallible.

Looking at Mountain Lion, it is hardly cutting edge innovation. If Apple thinks that taking existing features and repackaging them as separate apps constitutes innovation, then it is not hard to see at least one way in which Apple could fail. Furthermore, the treatment of corporate and professional customers might end up being the Achilles heel. Or web/cloud services. Or million other things.

There are, of course, plenty of positives as well. For one big one, Microsoft’s entrée to the tablet space looks a bit awkward – nowhere near as natural as Apple’s. Moreover, it is not like many of Apple’s competitors still understand marketing; one wonders when they stop selling crap and quality under the same brand or at least learn to come up with product names that don’t confuse prospective buyers.

This is not to say that the stock might not go higher in the short term or that you should short it, but it seems reasonable to me to seek opportunities elsewhere than to try to exit at the highs.

Just waiting to see which hedge fund blinks first…

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