The case for buying AAPL (as of 3/5/13)

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Disclaimers: (1) I own some AAPL stock. (2) I have no inside information on Apple, Google, Microsoft, Amazon or any other company mentioned below. (3) This blog post should NOT be considered as investment advice.

Context: I originally wrote this in an email to a friend a few weeks back, who suggested I should widen this to a larger audience. At that time (3/5/13), AAPL was at 432. I know it has gone up since then (461 as of 3/22/13, yesterday), but I am too lazy to update the numbers below. I believe my analysis remains valid at 461 as well.

As of March 5, Apple’s PE ratio is 9.75 (at $432). If you take out their cash holdings of $137bn (at 2012 year end, probably more by now), their effective PE ratio is 6.4. That is, at the current price and income rate, you will earn back your entire AAPL investment in cash in 6.4 yrs. Sounds super cheap to me. In comparison, Apple’s main competitors, Google is at 25.7 and Microsoft is at 15.5. They also hold substantial cash, but nowhere close to AAPL.

So, the only way I can think of where the above fails (on a relative fundamentals comparison) is if Apple’s earnings go down substantially, and Google/Microsoft’s earnings go up substantially.

On Google, I might be biased since I work there, but I think the near future is quite positive. And Google is making very diverse bets on the future (Fiber, self-driving cars, Glass…), so the future seems bright overall. Though its handling of the Google Reader shutdown gives me some small concern.

Microsoft, I am not so sure. If their tablet fails (and it hasn’t done well so far, but it’s only the first iteration, they have a couple more years to get this right), then they are in deep trouble. They won’t die suddenly, but will turn into an IBM. Almost to prove my point, MSFT has almost the exact same market cap as IBM right now.

So, on to AAPL’s future earnings…

The other AAPL divisions don’t make a ton of money compared to the iPhone+iPad, but there are 2 dark horses…

So that’s my analysis for why AAPL is undervalued. Now, I can’t be the only one who has thought the above, it’s all public info anyway. So why aren’t others buying AAPL? Why is the stock languishing at a sub-10 P/E ratio?

One possible reason is market manipulation, but I don’t really believe that. Market manipulation of such a large cap, widely followed stock sounds unreasonably difficult to sustain for this long. My best alternative explanation is…

People who agree with the above already own a lot of AAPL stock and they have lost a lot of (paper) money in the past 3-4 months. Some of them may have been forced to sell as well due to mark-to-market issues, driving the price lower for AAPL, but no one wants to add to their already substantial holdings. Basically, anyone who is optimistic about AAPL, was optimistic over the past 2 years as well and bought a ton of stock in the 500s and 600s, so they are afraid or out of capacity to buy any more. People who are pessimistic on AAPL have been shorting heavily, and given the lack of support from the buyers, the price keeps going lower.

However, as Apple continues to release strong earnings in future quarters, sentiment will reverse and there might be a big uptick. My price target for Apple is actually a P/E target, but unless something dramatic happens to change my view on the points above, I won’t consider selling Apple below a 13 P/E (ideally an after-cash-exclusion 9-10 P/E ratio).