Featured Articles

Mean Reversion: Why Apple Should See a Dramatic Rally

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

AAPL Previous Ranges1

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)

AAPL Expected Range1

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.


Pacific Crest Securities Blew It

January 16, 2013 (6:00 pm)

Can we agree on something? Pacific Crest Securities blew it this morning and have forever discredited themselves. They recommended to their clients that they sell Apple at the absolute low. They were shaken to the “core” (forgive the pun) and downgraded shares of Apple on a faulty assumption. In the short-term, Apple ≠ AAPL. But in the long run, they are one and the same. Technical’s may run the near-term price action, but fundamentals eventually take over.

Pacific Crest analyst Andy Hargreaves is “downgrading the stock to ‘sector perform’ giving it a price target between $440 and $550 for the next twelve months. The high-end market for smartphones and tablets are going to be saturated sooner than expected which will lead to poor growth for Apple.” Further, he explained that “demand for incremental hardware improvements is waning and [he doesn’t] believe people will continue to upgrade to a new iPhone.”

Right. So, where do we start?

PRICE TARGET: First, let’s take a look at the price target. He forecasts a $110 price movement over the next twelve months. This is extremely unlikely. We’ve been looking at quarterly volatility over the past few years, and the median price move in any given quarter is 3.3x the trailing twelve month P/E. Currently that P/E stands at $44.17, implying a $147.50 price move in any given quarter. Forecasting an entire year’s price range based on 2.2x P/E is completely without merit.

GROWTH OUTLOOK: Second, let’s briefly look at the smartphone and tablet markets. Over the past year, Apple has sold a total of 125 million iPhones and 58 million iPads globally. Fortune reports that China is estimated to have over 500 million smartphone users by the end of 2013. If Apple is able to capture just 10% of China’s estimated smartphone users in 2013, that would just about equal its entire 2012 iPhone sales. While that may not be a realistic goal, the point is that this single market illustrates the unbelievable growth opportunity ahead. Not to mention the fact that iPhone’s have barely started moving into India and Brazil. Besides these enormous emerging markets for new growth, let’s also look closer to home. Reports suggest that approximately half of all mobile users in the United States have a smart phone. With subsidies provided by the carriers allowing users to purchase an iPhone 4 for $0.99, what’s to stop the non-smartphone users from upgrading? Lastly, smartphone shipments are expected to top one billion in 2013. What share will Apple have?

Now let’s take a step into the tablet market. We’re going to approach this a bit differently. Forget about emerging markets. Let’s look at potential uses and users of tablets that haven’t historically used a powered device. Think of the global demand for a $329 consumer device that delivers a true computer replacement experience for a vast majority of the population. Now add students bringing a tablet to school in lieu of a heavy backpack filled with books. And doctors across the world replacing charts with a small, secure, wireless device (no more worrying about terrible handwriting). Then there’s the already evident demand from retailers looking to replace cash registers with iPads. Demand for this device is and will continue to be enormous. We don’t care if they sell more iPad mini’s than iPads – and we believe they eventually will. The higher volume will more than make up for the lower profit per unit. Especially because it locks users into its…

ECOSYSTEM. Andy also argues that demand for incremental hardware improvements is “waning”. He’s missing the point, at least with smartphones. Consumer behavior has been shaped by the telecoms. AT&T, Verizon and a majority of other telecoms have taught us to upgrade our phones every 18 to 24 months. They pay us to do so. When our contracts are up after two years, they deeply subsidize the newest phones. And we buy them. Let’s think about this for a moment from a purely anecdotal point of view.

For those of you living in New York, it’s likely that you don’t see as many iPhone 5’s as you would have expected on the subways and walking around the city. This might seem counter-intuitive, but we believe it’s a bullish data point. What we do see is an enormous number of older iPhone’s – namely the 4 and 4S. What’s going to happen when their two year plan is up? They’re going to get the newest iPhone. But this won’t happen immediately. And that creates a recurring revenue stream for Apple going forward. We’re locked in. The headache, heartache and expense of switching to Android or Windows is an enormous incentive to simply upgrade to the newest handset. But maybe not when it first arrives. When our contract is up. I’ll leave you with this thought: It’s the ecosystem, stupid. Let us know your thoughts.

The Law of Large Numbers: Has Apple Hit a Wall? (Featured Article)

The article featured below was contributed by fellow Apple investor Bhagwan “Bags” Motwani. Bags is an ex-CPA with a graduate education in financial markets and eight years marketing experience in the consumer wireless space. Bags also creates interactive Apple earnings calculators (access his latest 1Q2013 calculator here). You can reach him at bagsmotwani@gmail.com.

Has Apple Hit a Wall? (by Bhagwan Motwani)

January 15, 2012 (11:00 am)

Will Apple ever see $700 again? Has it hit the wall because it ran into the Law of Large Numbers? Is Apple yet another victim of history repeating itself?

Within the last dozen years, this history has had Microsoft see its market capitalization decline from $642 billion in 2000 to $226 billion today. Cisco reached its market capitalization peak of $557 billion in 2000, only to fall to $108 billion today. Does more pain await Apple as its market cap drops from its high of $661 billion in September of 2012 to $489 billion today?

Naturally, there are some key differences between Apple today and the Microsoft’s and Cisco’s of the tech bubble days, first and foremost being the insane PEs of these two giants (Cisco’s PE was 120x at its peak). Not to mention the animal spirits or irrational exuberance that goosed the market in the dot-com era.

But, do the market cap comparisons above tell us that there is an inevitability to gravity re-asserting itself and could what we have seen with Apple over the last quarter be indicative of this? And, worse, could it presage a continuing drop in Apple’s market capitalization (and by extension its stock price)? After all, earnings growth has and continues to decline as we look at decelerating and perhaps even negative earnings growth over the next few quarters.

This phenomenon, whereby market capitalization reaches a nadir and then declines precipitously, is commonly referred to as companies confronting the “Law of Large Numbers”.

In this article, we will weigh both sides of the argument as to whether the Law of Large Numbers will stymie Apple’s market capitalization and, by extension its share price, or whether the Law of Large Numbers is irrelevant and Apple’s market capitalization will be determined by other more germane factors.


Before we delve into this topic, however, some definitions may be useful.

The Law of Large Numbers is really a statistical term which states that the number of times an experiment is repeated, the average of the results will revert back to the mean. A perfect example would be the case of coin flips, where an increasing number of coin flips will result in something increasingly closer to a 50-50 split between heads and tails.

The financial markets and analysts have taken this term and modified its definition to represent the concept that a company cannot keep growing at a constant incremental rate for extended periods of time. A perfect example is Apple. The table below shows what happens when revenue and earning grow at 20% and 40% rates over 5 years.

AAPL Growth

If Apple were to successfully grow at 40% per year for the next 5 years, the company’s revenue would see more than a five-fold increase, EPS would reach $226 and the stock price, assuming a PE of 12x would reach $2700, for a market capitalization of $2.5 trillion. Just to put in in perspective, the value of the entire U.S. stock market is $15 trillion. A 20% growth rate over 5 years is also shown, and while more reasonable still represents a significant stretch. Clearly, compounded growth rates of this nature are both unrealistic and unsustainable and highlight the limitations that the Law of Large Numbers espouses.

Some very simplistic assumptions are employed in this table (for example Gross Margin remains the same, number of shares outstanding for the market cap calculation remains consistent). This was done intentionally to highlight the magnitude of change that compounding growth rates can drive, even over a relatively short period.

By the way, the Law of Large Numbers doesn’t necessarily mean that once a company’s market capitalization hits some kind of a theoretical wall, it is automatically going to slide back and never breach it again. All it says is that companies cannot afford to grow indefinitely at any given rate because the absolute incremental numbers for revenue and profitability get so big that they, in all likelihood, can never be met. Remember, nothing grows to the sky.

As for the definition of Market Capitalization, the term refers to the overall market value of the company and is simply the total dollar market value of of a company’s outstanding shares. It is easily calculated by multiplying a company’s shares outstanding by the current market price of one share. So, in the case of Apple, its market cap at the end as of December 31, 2012 was $503 billion.

The table below of U.S. companies with the Top 3 market capitalization’s over the last 3 years shows that Apple, despite its swoon over the last quarter, still managed by the end of 2012 to be the most valuable U.S. company.

Top 3 Market Caps (U.S. Companies)

Top 3 Market Caps


Given Apple’s price performance over the last quarter, some are asserting that the law of large numbers is already starting to have its impact on Apple. As conviction that growth is starting to slow, they offer the following evidence:

  1. Valuation: Apple’s P/E is less than 11 based on 2013‘s earnings while the markets P/E for the year is 13. This is a low growth valuation because investors are asking how Apple can get bigger. And, indeed, Q3 and Q4 2012 earnings reflected only high single-digit year-over-year growth, down significantly from the previous 2 quarters and below the growth experienced in 2011, proof that things are slowing for Apple.
  2. Competition: On a variety of fronts. While its ecosystem is vaunted, Apple may lose its edge as computing shifts to the cloud and it faces a slew of competitors from Microsoft to Google to Amazon. On the handset front, Samsung is the market leader in unit sales. Its Galaxy S3 and Note2 devices, with bigger screens, “phablet”-type features and innovations like NFC that enable devices to interact with each other put Apple at a disadvantage and call into question Apple’s innovation strategy.
  3. Stumbles: Production snafus and the Apple Maps debacle are just two of the more recent errors, allowing competitors like Samsung and Google to gain a foothold casting further doubt on Apple’s growth trajectory.

The upshot of all of this is that the valuation of Apple stock is 20% below that of the overall market – a P/E compression brought on by the concern that Apple has confronted the Law of Large Numbers and has lost.


Others do not subscribe to the Law of Large Numbers theory for Apple and feel that the stock looks like a bargain by any measure. They offer as evidence:

  1. Market Share: Apple has low penetration in world’s biggest markets – cellphones and PCs. Given that there are over 6 billion cellphone subscribers worldwide, Apple’s market share today is in the single digits, leaving more room for expansion. Expanding to carriers like China Mobile may be one such avenue. Ditto for PCs, where Apple’s 10% share offers some upside opportunity. Admittedly, the PC market is expected to be flat to slightly down, but Apple has room to grow relative share.
  2. Rapidly Growing Markets: Even in markets where Apple’s share is significant, such as for Tablets, the size of the market is expanding at a rate where relative market share declines for Apple (given the slew of competitive devices entering the market), are still expected to result in significant unit volume increases for Apple for the foreseeable future. Apple’s Tim Cook has been quoted as saying that there will be a day when the Tablet market will be larger than the PC market.
  3. Operating Leverage: The concept of Operating Leverage is one where fixed costs can be spread over a larger production base to provide gross margin advantages. This augurs favorably as Apple continues to grow its currently modest share in cellphones and as it continues to enjoy unit volume increase in Tablets as that market expands significantly. This operating leverage provides outsized gains in margins and earnings at slower rates of revenue growth.
  4. Next Big Thing: whether it be an Apple TV, wearable computing, different iPhone form factors or something else, Apple has a tradition of introducing innovative new products that should help fuel Apple’s growth engine.
  5. Recommended: Of the 57 analysts covering Apple, 50 still rate it a buy. Proof that there is confidence that the arguments offered above can continue to fuel Apple’s earnings growth.

Opponents of the Large Numbers Law are not naive enough to believe that the Law will never affect Apple. In fact, they believe that the Law of Large numbers will only begin to affect Apple once the products they compete with achieve critical mass from a market share perspective.


Nothing can continue to grow forever. Believing that it can defies the laws of nature and the laws of business. The critical question regarding the sustainability of growth concerns the point at which growth either starts to decelerate, slow down or reverse.

Apple bears argue that slowing growth was already evident in FY Q3 and Q4 earnings and that FY Q1 guidance points to negative earnings growth. What they’re essentially saying is that the Law of Large Numbers has started to assert itself and Apple will never regain its stock price highs of 2012.

Apple bulls contend that growth may have slowed, but this is a temporary situation caused by transition quarters where Apple was renewing virtually its entire product line. This led to demand hiccups, put pressure on supply channels, created production challenges and negatively impacted margins. Bulls feel that growth will resume and continued double-digit growth will re-assert itself going forward, leading to new highs for the stock in 2013 and beyond.

2013 will be a pivotal year in determining whether Apple is yet another victim of the Law of Large Numbers. If the bears are correct, 2012‘s comparisons will prove to be too much to overcome and flat or negative growth will be the outcome. If the bulls are right, Apple will have been successful in continuing to innovate and increase market share and will be able to delay its destiny with the Law of Large Numbers. But it will merely be a deferral, because at some point in time, the inevitability of the Law of Large Numbers will catch up, even with Apple.

Disclosure: I am long AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Written by Bhagwan Motwani.

Investing in Apple: A Two-Story Stock (Featured Article)

The article featured below was contributed by Fernando Olivares, a friend and fellow Apple investor. Fernando runs a website focused on day- and swing-trading Apple stock and options. His site, aaplspreadsheet.com, is highly recommended. Fernando utilizes a series of proprietary methods to determine likely near-term price moves. You can reach him at comments@aaplspreadsheet.com or via Twitter @aaplspreadsheet.

Investing in Apple: A Two-Story Stock (by Fernando Olivares)

January 10, 2012 (7:45 pm)

Apple (AAPL) bulls have been scratching their heads and licking their wounds ever since the stock finally broke the $700 barrier in mid-September. This extremely bullish price action (a very impressive 71% rally YTD at that point) signaled a top in the stock. We’ve been in a very severe downtrend ever since.

What we need to take from these actions are two things:

  1. The stock is not the company, and
  2. The company is not the stock.

Let’s run some numbers to get a sense of what I’m trying to convey here:

  • Apple’s LTM P/E ratio is currently 11.71x
  • Microsoft’s (MSFT) P/E ratio is currently 14.28x
  • Google’s (GOOG) P/E ratio is currently 23.18x
  • eBay’s (EBAY) P/E ratio is currently 18.04x
  • Amazon’s (AMZN) P/E ratio is currently 3,541x (yes, this is correct)
  • Facebook’s (FB) P/E ratio is currently 290.53x
PE Comparison

Click to enlarge. Excludes Amazon in order to keep the scale reasonable.

A P/E ratio by itself may be a weak way to measure a company, but humor me for a second. Between those companies mentioned, Apple is the least valued. This means that the market believes that Google or eBay should see higher growth than Apple. Also, the market believes that Facebook has an extremely bright future.

Now, let’s leave the market for a second and look at the facts. In FY2012, Apple earned $41.7 billion in profits, while the other 6 companies, which are considered tech giants, earned $34.4 billion in combined profits. So it is a fact that Apple is the most profitable and by quite a large margin. Note that three of those companies are software companies, which are usually insanely profitable.

This shows you that there is a very clear discrepancy between Apple the company, and AAPL the stock. The company, in general, is loved all over the world. Their product releases cause waves in the tech pond. People line up to buy their products, even when they already own the previous version. There is a devotion towards Apple products. It is clear that the stock is undervalued when it comes to the actual numbers, but this does not matter to the market, and the market is always right.

I know some people lost a lot of money because of their relentless faith in Apple. Their mistake is that they are unable to distinguish Apple from AAPL. The company is absolutely demolishing the competition, especially when it comes to profits. Phil Schiller just confirmed that they own 75% of the profits in the mobile space. Everyone is calling for Apple’s demise (and looking Samsung’s way) but it is unlikely that it will come in the next few years.

I believe that all of this information is not reflected in the current stock price because it is extremely difficult for us to understand this monster of a company. Nobody can believe that AAPL, a company that seems to make simple products, can keep growing. The constant growth that the company has experienced is mind-boggling. Of course we may see a slower growth this quarter or next, but what happens when they sign a deal with China Mobile? There are 700 million subscribers there. It’s simply too difficult for the investor community to understand that the biggest company in the world continues to have a lot of room to grow in both the smartphone and tablet industries.

The market is pricing Apple at a low valuation because a majority of participants do not understand its strengths. Do not fight it. What Apple bulls need to do is try to analyze when the market will again realize that Apple’s stock price is lagging. When will the market decide that Apple is a good investment again? My best guess is after January earnings (January 23). Another solid quarter and the stock might play catch up with the company.

For now, all I can say is this: If you are getting tired of Apple as an investment, it may be that you don’t understand it, or that you are not taking advantage of its volatility. It is a beast of its own. It’s basically Ajab’s white whale. Don’t expect it to be easy to profit from. I’m not saying that it’s impossible, but you need to be able to separate the successful company from the successful stock (remember, the shares still gained over 20% in 2012).

Disclosure: I am long AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Written by Fernando Olivares (aaplspreadsheet.com). Follow him on Twitter @aaplspreadsheet.