Income reports

Apple Stock is now a bubble (NASDAQ: AAPL)

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Apple’s stock has become unbalanced in its business

Many Seeking Alpha readers will consider this the height of blasphemy, but Apple Inc. (AAPL) – the most valuable company in the world and symbol of American capitalism – has become the object of a speculative bubble. Apple’s price is now far higher than its business fundamentals warrant without resorting to overly optimistic projections for the future. Apple made a average earnings report in October, after which the stock hit all-time highs. Also, this is just anecdotal, but the local Apple stores here in Texas weren’t as busy as I expected before Christmas.

Some observers have linked Apple’s surge to speculators buying short-term call options on the stock, a behavior more commonly seen in even stocks like GameStop (EMG) and AMC Entertainment (CMA). This would make sense, as the recent $500 billion increase in market capitalization does not match the reality on the ground. Apple now trades more than 30 times earnings, with the consensus earnings estimates from analysts expecting a peak this year or slow growth at best.

Apple Pricing Chart
Data by Y-Charts

Analyst predictions are increasingly abstract

If the current numbers are average, why is Apple stock outpacing the company’s earnings? Recent analyst reports seem to like to emphasize the abstract, as virtual realitythe “metaverse“, and the prospect of a apple car.

  • Virtual reality is interesting, but as someone who has played with technology (I walked the plank), it was kind of fun, but it didn’t change my life. Having a friend own one is as good as owning one yourself – a key contrast to the iPhone. Take Meta (Facebook), the company formerly known as Facebook. Meta sold around 10 million Oculus VR headsets. The sets start at $300, so I think with a 30% markup they made about a billion dollars out of it. A billion dollars is a lot of money, but it’s a lot less than $2.8 trillion (1/2800th of Apple’s market capitalization to be exact). I would expect Apple to play in VR, but I wouldn’t expect fireworks here from a profit standpoint.
  • The metaverse is another curiosity here. Silicon Valley has been swamped with whistleblowers lately, so what better way to draw attention to antitrust issues, jobs issues, and societal issues than to put your best marketers in a piece for a few days until they find something you can launch a huge PR campaign with? Apple isn’t the biggest driver of social issues coming out of Silicon Valley, but I wouldn’t have high expectations for the profit potential of the Metaverse – most of the use cases discussed seem indistinguishable from using of FaceTime.
  • There’s huge interest in electric cars right now, so the best way to build hype into a business (besides putting Bitcoin on your business balance sheet) is to generate speculation that you might produce an electric car. Apple has vast R&D resources, but getting into the automotive business for them makes just as much sense to me as building an Apple airline. The automotive industry is known to be labor and capital intensive and to have low margins. Apple might just license a car, but will manufacturers be willing to shell out the royalties Apple wants, and is Apple comfortable facing potential brand issues if the car ends up in recalls or security issues? I don’t think the automotive sector is a good fit with Apple’s expertise in consumer electronics.

Apple’s challenges for 2022 and beyond

1. Whether earnings estimates are realistic without continued fiscal stimulus is an issue for the broader US economy, but particularly thorny for consumer-facing companies like Apple. Apple had its best year ever in 2021 as consumers abounded in cash thanks to government stimulus measures. Not all of these concerns are specific to Apple, but they do affect the company.

2. The central question for 2022 and beyond is whether Apple’s pre-pandemic earnings in the roughly $3 per share range are more indicative of long-term demand for Apple products, or whether the 5 $.67 per share they earned in 2021 is the new Ordinary. I think earnings estimates for the stock market as a whole are too high for 2022 absent stimulus spending. (i.e. the typical US household earned about $60,000 after tax in 2021, but $10,000 of that came directly or indirectly from the stimulus, such as the three rounds of checks, the increase in the unemployment, student loan break, etc.). It turns out that if you give the typical American family an extra $10,000 to spend that they don’t have to work for, statistically a lot of those people will upgrade their iPhones. In the future, consumers will only be able to spend what they actually earn. Apple has tailwinds from services revenue, but I don’t think they can sustain iPhone sales anywhere near the level they hit in 2021. I’m guessing Apple is earning between 4.50 $ and $5.00 in 2022.

3. Apple quoted the supply chain as a challenge on their last quarterly earnings conference call. I think the supply chain will be less of a problem in 2022 than it was in 2021, but because consumer demand is weaker in the face of lower inflation-adjusted wages and no stimulus. That said, chip shortages won’t help Apple’s cause, and the longer they last, the more they’ll cap Apple’s earnings growth.

4. Apple’s goose is service revenue. However, Apple is increasingly coming up against antitrust laws. We’ve seen Apple cut App Store fees recently under pressure from regulators, and we’ve seen Apple and Google (GOOG) get scrutiny for the $About 15 billion that Google will pay to Apple this year for the right to be the default search engine. Apple gets more from its deal with Google than it probably ever will from the Metaverse. The risk is that regulators in the US or EU end up pushing this back and cutting off the flow of money here. This deal is worth about 1/6th of Apple’s net income for the year, and even more if iPhone sales slow.

5. Apple’s earnings per share growth was driven largely by buyouts. When Apple traded at a 10-12x PE for most of the 2010s, it allowed Apple to earn huge returns on the stocks it bought back. With a PE ratio over 30x now, this strategy is only 1/3 as effective and dependent on activity to continue to outperform at historically very hard to reach levels. I would rather see Apple pay a dividend here.

6. Believe it or not, Apple traded at a discount to the S&P 500 PE ratio for much of the 2010s. Now it trades at a large premium. I don’t usually make sentiment-based market calls, but I think a PE ratio closer to the S&P 500 as a whole (20x or so) is more appropriate than a big premium. There’s no particular reason for the market to apply this, but this is where I think it’s correct based on Apple’s underlying business. That would put the stock price around $100, and that’s about where I would buy the stock.

Conclusion

Since late 2019, Apple stock has been on an epic bull run. If this run had been fully reflected in the company’s long-term success, that wouldn’t be too much of a concern. But with Apple’s valuation increasingly reaching exuberant levels as concerns over the sustainability of its earnings mount, Apple’s stock has the dual problem of having earnings estimates that will be difficult to meet and to have a high valuation in addition. Formerly my biggest holding, Apple seems to be in a bubble here after its November gamma compression. Apple’s business is going to struggle to meet exorbitant expectations for the stock.