Category: Apple

Apple math

Apple just issued a brutal warning for the quarter just ended Dec 31:

– revenues of $84 billion, -4.9% (vs. previous guidance of $91 billion, a 3.1% gain)

– gross margin of 38% (vs. 38.4%)

– operating margin of 27.6% (vs. 29.8%)

We’ve felt Apple bulls have been guilty of recency bias and extrapolation for some time, especially with regard to its fat profit margins.  Annual operating margin has slowly drifted lower over the past three years, from 30.3% to 26.0%.  Where does that settle out for a company heavily dependent on one product in a market that is saturated and losing market share to a slew of feisty competitors?  Our best guess is 15%.  Worse, what happens to sales, especially as we head into a global recession?  We think down 20% from the peak is a strong possibility.  That would take Apple’s revenues back to where they were just 3 1/2 years ago.

With these assumptions, Apple’s earnings per share drop to $5.50 ($5.00 if you assume they squander their remaining cash on pricey buybacks all the way down, a safe assumption considering CEO Tim Cook’s assurances).  According to Yahoo Finance, the 42 analysts who follow the company expect Apple to earn $13.29 this year and $14.64 next.

Assuming the analytical herd has it wrong, what would you be willing to pay for such a company?  10x earnings?  Perhaps 12x assuming a turnaround?  8x in a worse case?  At $5.00/share in earnings, that gives you a stock price of anywhere from $40 to $60, i.e. 58%-72% lower than the current $143.42.

The importance of Apple to the foundation of the everything bubble cannot be overstated.  257 U.S. ETFs own AAPL, the most of any stock.  At just 10.8 x illusory “forward earnings,” Apple’s inflated margins help support the narrative that “stocks are cheap at less than 15 x earnings.”  Lastly, how much has AAPL’s outperformance over the past 10 years helped foment a bubble in passive investing where $2.0 trillion flowed out of active funds and $2.5 trillion into passive funds?  Indexing leader Blackrock (BLK) is down less than 2% on a day when AAPL is -9%.  For now, investors are failing to connect the dots…

 

Generals charge ahead while soldiers in full retreat

Friday was a remarkable day for students of the market’s internal strength, aka “market breadth.”  The Nasdaq 100 (NDX), powered by a 16% surge in Google, was up 1.45% even though declining stocks outnumbered advancing stocks by 50.  This has never happened on a day the NDX gained over 1%, not even close.  According to Jason Goepfert of SentimenTrader, breadth was negative only three other times in history.  One of those days was March 23, 2000 – right at the top of the Nasdaq bubble!

Year-to-date, the Wilshire 5000 (a measure of market capitalization of 5000 companies) has added $751 billion in market cap, a 3.5% gain.  By our measure, 10 companies have accounted for $471 billion, or 63% of those gains.  The top 5 have a combined market cap of $1.489 trillion – 6.6% of the Wilshire 5000 – and accounted for 52% of the ytd gains.

  • Apple: $113 billion, +18.4% ytd
  • Google: $107 billion, +31.8%
  • Amazon.com: $81 billion, +55.6%
  • Facebook: $48 billion, +21.7%
  • Gilead Sciences: $38 billion, +25.9%
  • Netflix: $29 billion, +135.2%
  • Celgene: $18 billion, +20.3%
  • Biogen: $15 billion, +19.2%
  • Regeneron Pharmaceuticals: $15 billion, +34.5%
  • Tesla Motors: $7 billion, +23.5%

Further, biotechnology stocks make up 3% of the S&P 500 by market cap yet account for 15% of the year’s gains.  Meanwhile, the Dow Jones Transportation and Utility Averages are 12.5% and 11.9% below their 52 week highs respectively, even though the Dow Jones Industrials Average is within 1.4% of an all-time high.

As legendary market watcher Bob Farrell warned, narrowing leadership is typical of the late stages of a bull market.  This phenomenon is even more pronounced during the blowoff stage of a financial bubble.  We call this the “casino effect.”  Gamblers, addicted to winning over a long period, refuse to leave the casino even though several tables are coming up snake eyes.  Instead they gravitate to the diminishing number of winning tables.  Regarding the stock market, this is a classic sign of denial.  The losing tables are in essence early warning signs, stocks succumbing to deteriorating economic fundamentals.  Yet speculators ignore the red lights and fail to connect the increasingly obvious dots.  At the end the investing crowd feels it is in control and their favorite stocks are immune to macro factors.

Apple is a good example.  In Q1, China revenue grew 71% and accounted for 29% of the total.  At what point do the troubles in China affect Apple, the beloved stock of retail investors and the biggest weighting in index funds?  We could get some clues this Tuesday after the close when they report Q2 earnings.

 

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