April 24, 2013 (6:30 pm)
With 20/20 hindsight, the fall of Apple’s share price is easily explained. The stock market is a forward-looking mechanism. And those investors that were looking forward saw how difficult it would be for Apple to achieve year-over-year earnings growth. Margins were impressively high last year. Even with the expected revenue gains, the likeliest scenario was for EPS to drop against previous periods. For those investors that saw this dynamic taking place, it wasn’t difficult to envision the headline “Apple’s earnings declined year-over-year”. At the time, however, we didn’t recognize that dynamic.
Apple’s Year-over-Year EPS (red) and Revenue (blue) Growth vs. Share Price (green)
Stock Declined Ahead of Negative Growth. Looking at the chart above, it’s clear that the market recognized Apple’s growth was not only declining, but actually turning negative. It is often said that the stock market tends to look six months forward. That makes a lot of sense here. The high in mid-September 2012 took place just about six months before a dramatic year-over-year decrease in earnings. While the earnings decline for the December quarter was only $0.07 from the year ago period, the March quarter saw a decline of well over $2.00. And the June quarter is likely to see another $1.50 or so decline compared to the previous year. But we believe that is now priced into the stock in the low $400’s. The real question is where do we go from here?
In our estimation, Apple shares are nearing a turning point. The Spring and early Summer may see choppy price action, as earnings are going to continue to decline year-over-year. We expect the last twelve month (LTM) earnings to decline from the current $41.89 to a trough in the high $39’s during the September (fiscal 4Q2013) quarter. But, again, the market is a forward-looking mechanism. So this will very likely be priced in before we get to that point in time. Once investors can see past the negative growth phase, it will begin to factor in the shift towards positive growth and drive another steep rally.
Apple’s LTM Earnings (blue) vs. Share Price (green)
The shares of Apple topped out months before the earnings growth rate turned negative. We expect the same reaction months before earnings return to positive growth.
Buyback Effect. With the buyback announcement last night, one factor that most analysts have not incorporated into their models is a decreased float (share count). This artificially boosts earnings per share – earnings are what they are (i.e. they remain constant), and share count decreases, driving an increase in EPS. With roughly $58 billion remaining in their buyback “war chest” to be utilized over the coming 32 months, we expect 12 million shares to be repurchased each quarter. This figure conservatively assumes a $450+ share price for the repurchases. This adds (again, conservatively) $0.10 to each quarter’s EPS – and it is cumulative. After ten quarters (2.5 years), this will add about $1.00 to earnings.
Fiscal 2014: Dramatic EPS Growth. And this is precisely why we expect the share price to once again rally hard later this Summer. Starting with the December (1Q14) quarter, we expect Apple to again show earnings growth. Its organic EPS growth will be boosted with the buyback affect and create pretty dramatic growth. And because of its relatively “weak” fiscal 2013 earnings per share figures, the year-over-year comps throughout fiscal 2014 will easily beat on a year-over-year basis and show strong growth. To give you a high-level sense of our estimates, we expect the LTM EPS to surge from the high-$39 level in September to the very high $40’s during the course of fiscal 2014.
Round 2. During the one year period when the LTM EPS jumped from $35 to $44 ($9 per share), the share price rose from $440 to a high of $705. What will happen in the anticipation of LTM EPS once again climbing $9 per share – from $39 to $48 in fiscal 2014?
Let us know how you think this will play out.