What to do About Apple

Date: 27 April 2010

There has been a lot of investor interest in the stock of Apple Computer (AAPL), and rightly so. The share price has spanned a 52-week range of $119 to $272 per share. This represents a quick double for investors fortunate enough to purchase below $135.

Apple has also captured the attention of the consumer in both American and international markets. New products continue the string of innovative offerings like the iPad, update MacBook Pros, and soon a new iPhone.

An investor must examine the current 12-month trailing PE of 23 and determine: is the stock risen enough to become a sell? Is it too late to buy?

Disclaimer: I currently own shares of AAPL, having bought shares in Sep 2008 at $105, and additional shares in Jun 2009 at $140. No part of this posting should be considered as investment advice. Perform your own analysis and decide for yourself if AAPL is right for you.

AAPL posted EPS of $3.33 per share in the most recent quarter, an increase of 86% over the previous year. Analysts project AAPL’s growth rate at 18 to 20%, though the five year EPS growth rate has exceeded 50%.

Typically, I use the quarterly results after 2 or 3 quarters are reported to start projecting possible EPS values 5 years in the future, but a more conservative approach is to start the projection as the 2009 EPS value of $9.08. Assuming a EPS growth rate of 20% yields a projected value of $22.59 per share. The figure below shows this growth projection (click on the figure to open a larger version).

Apple stock study 1

Apple Computer – Sales, Pretax Profit, and EPS Growth

So, is a 20 PE ratio expensive for a stock like AAPL? Have the momentum investors and hedge funds pushed the price too far? Does the answer differ if the growth rate meets the historical growth of 57%?

Apple stock study 2

Apple Computer – EPS & Growth Analysis

AAPL’s High PE ratios spanned a range of 20.8 in 2009 to 39.4 in 2007. I removed the three highest PE ratios of 38.6, 39.4, 337.9. This gives an average High PE ratio of 29.1.

The Low PE ratios spanned a range of 8.6 in 2009 to 21.4 in 2006. I removed the highest of the Low PE ratios of 21.4. This gives the average Low PE ratio of 14.7. In non-recession conditions, the Low PE ratio is closer to 18 to 20.

If the Recent Market Low price of $72.6 in 2007 is used, the Up/Down ratio is a hold at 2.0.

Next, what if we assume that AAPL won’t reach $73 again? After all, this price was before the iPad introduction, and before accounting rules changes that allow AAPL to book iPhone revenues sooner.

Apple stock study 3

Apple Computer – EPS & Growth Analysis

If we set the low price at a PE ratio of 14.7 which equates to $133.48, the Up/Down ratio improves to 2.9, near our buy criteria of 3.0.

This analysis was at a closing stock price of $269.50 per share, a trailing PE of 23, and a leading PE of 19. The 5 year average PE ratio has been 25.

AAPL has no debt, and $23.155M in cash on hand. The most recent quarter show remarkable strength, since it did not include the Christmas quarter.

Overall, I am still holding all of my AAPL shares. I must admit that I am more cautious now, and will consider sell 1/3 of my current holdings if the price rises much more. I have maintained a position in AAPL since 2008, though I have bought and sold additional shares around this core holding.

Bottom line: Like any stock, you should be able to find a buying opportunity at a lower price. The most important thing to remember is (1) don’t chase a momentum stock to unreasonable price, and (2) diversification is the only free lunch in investing.

NOTE: Stock selections in this post are for educational purposes only and is not intended to be a recommendation to purchase or sell any of the stocks, mutual funds, or other securities that may be referenced. The securities of companies referenced or featured in this web site are for illustrative purposes only and are not to be considered endorsed or recommended for purchase or sale. Investors should conduct their own review and analysis of any company of interest before making an investment decision.

Securities discussed may be held by the author in his own personal portfolios.

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