Apple Stock Is Still Cheap

My 10-year-old daughter, Julia, and I were recently discussing the stock of Apple (symbol AAPL). “Dad, everybody owns it already!” she said. For me, it was a Joe-Kennedy-and-the-shoeshine-boy moment—in reverse. The market is terra incognita for Julia, but she is certain about one thing: Apple is over-owned. After all, Julia owns the stock. So does Mom. And Dad. And the parents of many of her friends. Who in her orbit doesn’t know by now that Apple is a great company?

Super Cheap

Apple, the world’s most valuable company, with a market capitalization of $567 billion in early July, is at a fascinating juncture. Its earnings rose 78% in the fiscal year that ended in September 2011. Yet its price-earnings ratio is less than the market’s—much less if you strip out its vast cash hoard. Reducing the share price by the amount of the stash (now $110 billion, or $117 a share, estimated to reach $205 billion, or $213 per share, by September 2014), Apple, at $606, trades at just 9 times estimated earnings for the year that ends in September 2013. The market is essentially saying that Apple is a below-average company and it will stop growing after this year.

The low value reflects a strong “we won’t get fooled again” chorus. Investors know that when other stocks hit the $500 billion market-cap mark, they have, without exception, stalled (ExxonMobil) or crashed (Cisco Systems, General Electric, Intel and Microsoft).

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Then there’s the dreaded disease that infects once-mighty mobile-device leaders. Motorola, Nokia and Research in Motion have all fallen. Nokia’s stock is down 95% since 2000, RIM’s 95% since June 2008. And remember Sony? In a recent blog titled “Apple=Sony,” tech analyst George Colony, CEO of Forrester Research, predicted that without Steve Jobs, Apple would slide into mediocrity.

Grotesque misperceptions surround Apple, with many investors fighting the last war, the one in which every tech titan inevitably gets its comeuppance. Moreover, familiarity with Apple has bred contempt in two distinct ways. First, its products are so ubiquitous that it’s hard to imagine that the company can keep growing. Second, making money in Apple doesn’t garner an investor much respect. No one cares that I have a ten-bagger in the stock. So does the pharmacy delivery guy—and his podiatrist. Owning Apple has been an obvious play for so long that, for many people, the bull case has become uninteresting.

But not to me. Apple accounts for 8% of my portfolio. But I am a piker compared with David Einhorn, of Greenlight Capital, who has 16.6% of his $5.1 billion hedge fund in the stock. In a letter to clients, he explained why. Over-owned? Einhorn’s response: The average hedge fund has less than 2% of its money in the stock, although Apple accounts for 4% of Standard & Poor’s 500-stock index. (Apple is actually under-owned, Julia.) Worries about a $1 trillion market cap? No law against it. Growth must slow? Apple, Einhorn contends, is really a software firm rather than a hardware maker. That makes it much less likely that some new device will do to the iPhone what the iPhone did to Motorola’s RAZR and RIM’s BlackBerry. Apple’s value, says Einhorn, “comes from iOS, the App Store, iTunes and iCloud.”

Needham analyst Charlie Wolf says the market’s fear that wireless companies will cut their iPhone subsidies is groundless. Citing game theory, he says that would happen only if all carriers agreed to do so at once, which would be illegal. More significant, Wolf says, is what the market is missing: “Apple is a small player in two big markets—smart phones and PCs.”

Will Apple achieve a $1 trillion market cap by 2014, as Piper Jaffray’s Gene Munster predicts? I don’t know. But the surprises over the next 18 months are much more likely to be positive than negative. Yes, someday Apple won’t be cool. But not yet.

Columnist Andrew Feinberg manages a New York City–based hedge fund called CJA Partners.

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