Markets & Finance

Marcial: Apple Is Ripe for the Picking


These days, Apple's beaten-down stock looks like an appetizing "value" play based on the company's potential for earnings and sales growth

Apple Inc. (AAPL) is definitely ripe for the picking. After reaching a 52-week high of 202.96 on Dec. 27, 2007, the stock plunged to a low of 80.49 on Nov. 20, 2008. (It closed at 82.58 on Nov. 21.)

What's interesting here is that Apple is one of the few "growth" stocks that has morphed into an appetizing "value" play, trading way below its intrinsic, or asset, value. Apple, of course, has long been a household name, thanks to an array of innovative products—from the sleek Macintosh computer to the wildly popular iPod and iPhone—that have won the Cupertino (Calif.) company praise for its creativity and design savvy.

But plaudits are hard to come by in the stock market these days as shares of many iconic companies continue to get hammered. Faced with a global recession and the stock market's plunge to its lowest level in many years, shares of Apple have been severely beaten down.

Perhaps it's time for investors to "think different." The strong consumer appeal of Apple's products is widely known, but it is the compelling attraction of Apple's stock that needs renewed reflection. The case for Apple is simple: Its stock is cheap based mainly on strong earnings and sales growth, and the outlook for further expansion of sales and profits. And the stock's profile based on such benchmarks as its technical chart pattern and price-earnings ratio affirms Apple's attraction.

Standard & Poor's analyst Thomas Smith, who recommends buying the stock, says his optimistic opinion reflects the potential he sees for some new products to spur sales. "We also believe present valuation levels are attractive for the pace of earnings-per-share growth we anticipate," he adds. Apple continues to provide what he describes as "simple, superior, and differentiated products." Smith concedes, however, that gross margin trends may narrow as demand for consumer electronics is likely to soften because of the U.S. economy's downturn. (S&P, like BusinessWeek, is a unit of The McGraw-Hill Companies (MHP).)

Indeed, some analysts worry that the major risk in Apple's otherwise rosy story is the macroeconomic story, specifically the depth and length of the current recession. Even so, Apple fans believe the stock remains strikingly attractive at its current price.

"We believe Apple's valuation is compelling, given its cash of $27 a share and prospects for $10 a share in free cash flow in fiscal 2010," says Ben Reitzes, tech analyst at Barclays Capital (BCS). He rates Apple, a client, overweight with a 12-month price target of 113 a share. Apple ended its fiscal fourth quarter with $24.5 billion in cash. In that sense, "Apple has turned into a free-cash-flow-generating machine," says Reitzes. Surprising as it seems, says Reitzes, Apple has become an appropriate investment for "value" investors.

Based on fourth-quarter results, the iPhone has emerged as the largest revenue and income generator in Apple's product portfolio, says Charles Wolf, tech analyst at investment bank Needham, who owns shares. He is maintaining his rating of strong buy, with a 12-month price target way above those of other analysts: 240 a share.

The iPhone, iPod, and Mac lines are expected to drive continued sales and earnings growth at Apple. S&P's Smith expects the company's revenues to grow at a 15% pace in fiscal 2009 (ending on Sept. 30), and at 22% in fiscal 2010. All of Apple's major products have been refreshed and improved ahead of the yearend selling season, he notes. New iPhone models, says Smith, have been available since July 11, and new iPods have been out since Sept. 9. And the new MacBook PCs have been on the market since Oct. 14.

Smith figures Apple is worth 137 a share, based on 24 times his projected earnings of $5.70 a share in fiscal 2009. For fiscal 2010, he estimates earnings of $7.30, aided by a healthy balance sheet. That p-e of 24 is still below the historical upper range of Apple's p-e. It was as high as 98 in 2004. Last year, Apple's p-e went as high as 52 and as low as 21.

With Apple's solid balance sheet and hefty cash stash—it has no long-term debt—the company could either buy back its owns battered shares, or initiate dividend payments. Or maybe do both.

Any of these moves could propel the stock higher—possibly way above the 100 level once again. That's probably one of the reasons why most analysts are still upbeat on Apple. Of the 34 analysts who track the stock, 27 call it a buy, and five rate it a hold. Despite the gloomy economic outlook, only two analysts tag it a sell.

For investors who already own the stock—and who, obviously, may have bought in at much higher prices—Apple's currently depressed price marks an attractive opportunity to add to their holdings of this technology leader. And the current price also represents a nifty entry point for those who have never owned the stock. Apple's whiz-bang products fetch premium prices, but its stock is looking more and more like a bona fide bargain.

Unless otherwise noted, neither the sources cited in Gene Marcial's Stock Picks nor their firms hold positions in the stocks under discussion. Similarly, they have no investment banking or other financial relationships with them.

Marcial writes the Inside Wall Street column for BusinessWeek. In 2008, FT Press published the book Gene Marcial's 7 Commandments of Stock Investing.

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