February 5, 2013 (1:00 pm)
In our January 16 post rebutting Pacific Crest Securities analysis of Apple’s likely share price range for 2013, we explained that the average quarterly volatility for shares of Apple over the past few years has been roughly 3.3x the trailing twelve month earnings. With current LTM earnings of $44.10, this quarter’s price action should range $146.80 from low to high. Based on the low price of $435 this quarter, this range implies a high price of $582 during the current quarter.
The table below outlines our data set. It compares the low PE to the high PE in order to find the volatility each quarter, as measured by a multiple of earnings. This allows us to compare volatility ranges across multiple quarters. Note that the data is based on calendar quarters, not Apple’s fiscal quarter.
Quarterly Volatility Based on PE
Based on the data above, we determined that, since 2009, Apple has a median volatility of 3.3x LTM earnings. We view the median as a more conservative measure than the average, since the few higher volatility quarter’s skew the average higher than it otherwise would be. The “Quarterly Change” column captures the low, average and high volatility during the relevant time frame. The “Implied Price Range” applies that volatility to the current LTM earnings of $44.10. The “Implied High Price” adds the implied price range to the current quarterly low of $435.
Expected High Price During Current Quarter (Based on Historical Volatility)
Even the lowest volatility we’ve seen over the past four years would get the shares to $540, or a 22% rally from yesterday’s closing level. The four-year median of $580 implies a 31% price appreciation in the next 10 weeks.
We’ve reached the conclusion that, if the current low holds, Apple should see a dramatic rally at some point over the next 10 weeks. But what’s to say the current low holds? The obvious question is: “what if the post-earnings high of $466 represents the high price this quarter, and the price range simply means the low will be significantly lower (i.e. $466 – $146 = $320)”?
What gives us comfort that the price will not go dramatically lower? The concept of reversion to the mean does. The chart below depicts the Apple PE vs. the SPX (S&P 500) PE. Apple’s PE has, over time, traded near that of the broader markets. When it overshoots to the upside, it corrects back down. Conversely, when it drops well below the SPX valuation, a rally brings it back in-line. Apple’s current 10.0x LTM PE is 5.0x lower than the broader markets. Apple is trading at 67% of the average public company’s valuation. Yes, expected future growth has declined from 40-60% to 10-30%. However, the expected growth is still slightly higher than the average public company. We see the current correction as an overreaction to the previous dramatic rally, and expect shares to climb over the coming weeks and months to align more closely with the SPX.