Rising short interest indicates investors are betting against Apple Inc (NASDAQ:AAPL) stock due to rich valuation.
In the year-to-date period, shares of Cupertino based iPhone maker, Apple Inc (NASDAQ:AAPL) have rallied by over 50%. While this is a massive rally for any company, but, given the size of Apple Inc, this rally is even more impressive. Apple Inc added close to $285 billion in market cap this year alone. On the other hand, Apple's revenues have grown by 6% in FY 17 and net profit grew by 5.8%. So, what is driving the Apple stock rally? A hope of an iPhone supercycle. Analysts are expecting Apple revenues to grow by a massive 19.6% in FY 2018, largely driven by the recently launched flagship iPhone X. AAPL stock is part of Amigobulls' top stocks to buy portfolio which has outperformed the Nasdaq Composite.
Investors are betting against Apple stock
However, there are many who believe the rally in AAPL stock has gone too far and iPhone sales may come below expectations. Investors have already started betting against Apple stock. In the latest fortnight, short interest in Apple stock jumped by a massive 28%, indicating a significant rise in bearish sentiment. The total number of shorted shares increased from 33.49 million to 42.83 million, an increase of over 9 million shares. Surging short interest in Apple stock indicates that investors are expecting a correction in the near term.
AAPL stock trading at rich valuation multiple?
There are a couple of reasons for the rising short interest. Firstly, some investors believe that AAPL stock is trading at very rich valuation multiples and secondly, iPhone sales may not be able to meet the street's expectations. The year-long run-up in AAPL stock price has driven the valuation multiples higher. Apple stock's trailing PE has risen from 13.4x a year back to 19x now and PS (ttm) has gone up by 70% in the last one year from 2.7x to 3.9x. This rapid expansion in Apple's valuation multiples has several investors worried. Research firm Instinet advises caution as the valuation multiples for Apple stock have hit seven year high. A one point contraction in PE multiple will lead to $9 or 5% correction in the stock. The risk/reward proposition on the stock is less compelling now than it has been a year ago.
Of course, this wouldn't be a concern if Apple is able to deliver strong growth. And many expect Apple to deliver better than expected growth in FY 18 driven by the strong demand for iPhone X. However, recent reports by some analysts have been skeptical when it comes to iPhone Supercycle. A recent report was cautious when it came to iPhone sales estimate. According to the survey of some 6,700 people in five regions, conducted by UBS, an increasing number of people are willing to pay more for a smartphone. This is a good news for Apple as its latest iPhone models are pricier than previous models. However, the survey also found that intent of purchasing a smartphone was flat to down compared to previous year. The report also stated that in China, which is a significant market for Apple, consumers are likely to purchase local brands rather than Apple.
What does it mean for investors?
If the above scenarios turn out to be true then AAPL stock could definitely see a correction. However, you must look at the above report with a pinch of salt. The survey was conducted before the iPhone X was available in the stores for customers to check it out. There are several anecdotal reports and surveys which indicate the demand for iPhone X remains quite strong. Even Instinet analysts who are cautious due to Apple's valuation multiples expect a strong demand for iPhone as they find iPhone appears to be selling out everywhere without any promotions from the carriers. The Instinet report states that "TMUS noted that the X has seen great demand and better supply than anticipated. Both TMUS and VZ expect X demand to spill into March. Fewer promos likely recognize the telcos are selling all they have." Apple had also witnessed massive pre-order demand for the iPhone X in late October. And iPhone usage data from Mixpanel indicates that iPhone X adoption has improved by over 50% in the last two weeks.
Improving margins can support higher Apple stock multiples.
iPhone X sales will be the main driver for Apple stock in the near term. Any indication of slacking demand could lead to a correction. So, investors must remain cautious. However, the fourth quarter earnings report presented a strong picture of Apple's business. The company is delivering strong performance on several fronts. iPad sales are growing again. For the second consecutive quarter, iPad sales showed double-digit YoY growth. This was also the best year ever for Mac, with the segment reporting highest annual revenue in Apple's history. And for the third consecutive quarter, Apple Watch unit sales grew by over 50% YoY.
Then there is the services segment which includes revenue from AppleMusic, AppleCare, Apple Pay, licensing and other services. Over the last five years, the services segment has grown at a CAGR of over 23%. It will continue to grow at a rapid pace in the coming years. The best part of this segment is its high margins. According to an estimate by Piper Jaffray, the services segment has a gross margin of around 60%. Considering that the services segment already contributes 13% of Apple's revenue and this share will continue to grow in the future, Apple could see an expansion in its profit margins. The rising profitability could easily support higher multiples.
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