The bullish case for Apple

This post by Brett Arends on MarketWatch makes the best case for Apple bulls that I have seen. Arends writes:

If you haven’t been living in a cave for the past week, you’ll know Apple’s stock price recently collapsed to $445, from a peak of $700 last year. Wall Street suddenly discovered that Apple faces competition from companies such as Samsung. And Apple didn’t give a confident outlook for the year ahead.

But this is still a fantastically successful company, and the stock is dirt cheap by almost any measure.

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Let’s start with the basic numbers. Apple’s latest quarterly earnings show the company has $169 billion in cash and liquid assets, and just $69 billion in total liabilities. So the company is basically sitting on $100 billion in cash or equivalents — about $105 per share. (It has another $24 billion in commitments to buy components and pay leases on retail stores. Including those would change the numbers a bit, but not much.)

In short, Apple isn’t really a $445 stock. Net of cash, it’s a $330 stock.

That’s just seven times forecast earnings of $45 per share for the current fiscal year, which runs through Sept. 30. That’s half the rating of the rest of the stock market, which has historically traded at about 14 times forecast per-share earnings.

At current prices, Apple, net of cash, is less than six times forecast cashflow per share.

This analysis makes sense. Here’s a bullet point version of the bull case Arendt presents in a nutshell:

• Low multiple: Apple has a lot of cash that you need to subtract to get a better sense of Apple’s true cashflow or earnings multiple (ex cash) as that multiple represents the number of years’ earnings one is paying for per share of Apple stock. Net of cash, Apple’s a $330 stock. Once you net the cash out, you get a ridiculously low multiple like 6 or 7 times earnings or cashflow.
• Brand quality: Not only are people willing to pay more for Apple as with LVMH or Tiffany because of brand stickiness is good, Apple’s brand promotes stickiness. As Arendt puts it, “Everyone I know who owns an iPhone loves it. Apple customers are fanatics.”
• Customer service: Arendt has a horror story about another mobile platform: “For work purposes, I recently bought a tablet on a competing platform. It’s been trouble. The software’s buggy. I had to wipe the hard drive and reboot twice. The store won’t take it back because it’s outside the return period. The manufacturer will take it back, but I’ll have to ship it off for six weeks. I wasted hours online with their overseas help desk.” That is not the kind of thing that promotes brand or platform stickiness. 

Now, Jeff Cox at CNBC notes that there are some technical reasons for Apple’s downward momentum, namely its use in paired trades. And that could have added downside momentum to Apple’s shares. If you believe that Apple is still a great company with great execution which will continue to beat earnings estimates and grow earnings, it’s worth more than 6 or 7 times earnings ex cash.

The key  here is whether you believe present earnings represent a baseline case for future earnings. If earnings shrink drastically, then the six times forecast cashflow is really something like 15-20 times a future Apple cashflow. What I have written recently is that I expect Apple’s earnings to shrink. Moreover, I expect Apple to miss earnings estimates, putting downward pressure on its already downward momentum. If Apple misses this March, then the shares could easily fall below $400 a share. So, at this point, its unknowable when the fall in shares will be arrested. We need to look at how Apple deals with slowing growth and declining margins to understand whether earnings decline. If they do decline, I would expect shares to go lower.