- Many may believe Apple is becoming a value stock but I see revenue growth continuing meaningfully for its iPhone.
- Earnings multiple has never been cheaper. One could pick up the stock even cheaper by selling put options when implied volatility is high.
- The company's ability to consistently raise its prices will withstand global economic weakness concerns or sustained dollar strength.
Being more of a value investor than a growth investor, Apple (NASDAQ:AAPL) stock never really interested me but its current valuation definitely will put a floor under the stock. I suspect value investors will begin to flock to this stock now, especially after CEO Tim Cook confirmed that the company will raise the dividend again this summer. The stock is down almost 8% YTD despite reporting earnings of $18.4 billion last month which was its first fiscal quarter of 2016. Nevertheless, despite the earnings beat in the first quarter, the company missed on topline ($75.9 billion compared to $76.54 expected) mainly due to poor growth in iPhone shipments, impacted by the slowing economic growth in China. Therefore, the company is now projecting its first annual drop in top line sales in 13 years which has the street worried. Analysts are now predicting just over $227 billion in top line sales this year, which is $6+ billion lower than 2015 sales.
Revenues and EPS figures are expected to bounce back meaningfully in 2017 but because consensus has been falling over the last 90 days, Apple stock price has suffered as a result. The dividend is currently 2.15% but I'm suspecting we will get a 10% hike this summer (up to around $0.57 a share every quarter), which would bring the yield to just under 2.4% at the current stock price. The company intends to sell $12 billion worth of bonds to fund ongoing share buybacks and dividend. Borrowing for shareholder returns is only being done for tax advantages. Apple's balance sheet is rock solid and here is how I would invest in the company going forward.
Firstly, the tech stock currently has an earnings multiple of 10.3 which is well off its 5 year average of 14.3. Furthermore, its sales multiple of 2.4 is also well off its 5 year average of 3.3. Remember we are dealing here with a company that demonstrated robust growth across all majors metrics over the past 5 years (Revenue, earnings, free cash flow, etc ) despite the recent slow down. Competition may be increasing in the smart phone market for example, but switching costs definitely persist and I foresee Apple attempting to distant its products even more from the competition in future product launches. Furthermore, one can't discount the potential for further robust iPhone growth when you consider smartphone ownership in the world is still in its infancy. So, when you combine these newcomers with existing iPhone upgrade cycle of current owners, meaningful growth will continue as long as the company nails model updates to ensure fierce competition is kept at bay.
Therefore, if we take its present 12 month trailing EPS ($9.39) and multiply it by our average 5-year earnings multiple of 14.3, we get a share price of $134.27 which is almost $40 above the company's current stock price. It appears to me here that the risk/reward is to the upside. Therefore, assuming the downturn in the stock is not done, we can consistently sell puts to bring in more income. For example, the April 8th - 92- put is selling for about $143. If at the time of expiration, Apple is trading for less than $92, we get "put" 100 shares of stock at $92 for every contract sold. Now here is the skinny. Owning Apple at $92 will give you the stock at a p/e ratio of 9.79 (under 10) which is unheard of for a company like Apple. This strategy requires less up front capital and the opportunity to get this behemoth at an even lower price than it is currently trading for at the moment.
So, when is the best time to bring on this strategy? One should execute this trade when implied volatility is high (which is not at present). As you can see from the chart below, implied volatility for Apple is at the lower end of its range (just over 20) and preferably we need this to be much higher as option premium is much higher when IV is high. Last month before earnings, for example, IV spiked to almost 60 which would have led to an increase in the price of the put options and since we are sellers, this would benefit us handsomely.
Finally, if there was any stock which should rally substantially on dollar weakness, it would be Apple. Investors forget that Apple's revenues only climbed 2% last quarter (would have reached $80 billion in a currency neutral basis) due to sustained dollar strength and not any fundamental weaknesses. Yes, iPhone's sales only grew by 0.4% last quarter but its average selling price rose to $691 per unit which was a 3% rise on a rolling quarter basis. I just don't see anything fundamentally wrong despite the market seemingly believing that the iPhone is in a secular decline. Use the street's bearishness to go long on Apple stock, using the strategy I've outlined above as either you will bring in more income or pick up Apple stock at an even cheaper price than what it is trading at today.
To sum up, I believe the market is wrong about Apple stock at the moment as I believe recent earnings only painted a sluggish macro economic picture along with continued currency issues. I still believe Apple's fundamentals are intact as I don't see a real alternative to the iPhone that could steal meaningful market share. The company's premium brand and pricing power are still intact as evidenced by the $691 price-tag iPhones sold for last quarter.