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The Risk-Reward Ratio On Apple Makes It A No-Brainer

June 25, 2013 | About:
Intelligent Speculator

Intelligent Speculator

6 followers
I don’t need to convince you that saying that I like Apple’s stock is not a very popular view these days. It used to be unanimous and for years Apple would still beat expectations quarter after quarter, both on its top and bottom lines. That has obviously changed, and owning or believing in Apple (AAPL) is the type of thing that you almost feel like keeping to yourself.

My Case For Apple

I always talk about the risk vs reward paradigm, and I certainly feel like that is the main case for buying Apple. First off, a few important facts about Apple.

-Trades at a P/E of 10.22: To give you an idea, that is cheaper than companies like

Intel Corp (INTC) 12.69

Microsoft (MSFT) - 13.06

IBM (IBM) 13.19

Cisco (CSCO) 15.32

When I look at recent growth in revenues and earnings, I don’t see something that would justify such a valuation.

What Would Justify Apples Current Valuation?

The main thing that would justify such a P/E, in my opinion, would be for Apple to have more downside potential. I don’t see that happening anytime soon. To me, those companies are good examples of what Apple could end up being in a worst case scenario. The main concerns for Apple shareholders such as myself are:

-No New Products: One of the big concerns for shareholders has been the lack of new products. Ever since Steve Jobs left the company, Apple has been living off of its main products (iPhone, iPad, iPod, Macbook, etc) with little to no innovation. There have been rumors that products such as the iTV and the iWatch will soon launch, but those have been going on for a long time now with no results.

-Decreasing Margins:There have been rumors of a cheaper iPhone coming to the market and there is a debate over the benefits and downsides of such an approach. It’s unclear how good of a move this would be, but I don’t think anyone expects margins on existing products to improve. The fact is that competing products are getting better and Apple can no longer get away with the margins it enjoyed for a few years in the smartphone and tablet markets especially. For margins to increase, new products will need to become a major part of Apple’s business.

Of course, I wouldn’t say that these are foregone conclusions. Tim Cook has already confirmed that there would be many new products launched in the coming months (iRadio was the first announcement just a few weeks ago).

Declining margins are certainly a worry, but it’s far from a done deal. Also, declining margins in a market that is growing very strongly (and should continue doing so for some time to come).

If Apple is on pace to make $40 or so per share this year in what anyone would say is a down year and that we agree that Apple’s P/E is not going to get much lower, I think it’s reasonable to expect Apple to have a floor that is actually not too far from its current levels.

The Upside Remains Significant

Apple remains an incredibly strong franchise that could end up launching a big new product (such as a TV) in the coming months and that will continue to roll its existing products for some time to come. It’s also very reasonable to expect Apple’s P/E to come back up, which in itself would have a significant impact. I also think its way too early to give Android the victory over Apple. The fact is that there is a clear group of consumers that will continue the closed/simple ecosystem and lineup of products that Apple provides.

Apple also has an infrastructure of users that buy content through itunes, which, in many ways, is second only to Amazon in terms of merchandise search engines

asymco.png

credit Asymco

When I look at Apple, I see a stock with very limited downside, but fairly significant upside, exactly the type of trade that I look for.


Rating: 3.4/5 (8 votes)

Comments

batbeer2
Batbeer2 premium member - 1 year ago
>> When I look at Apple, I see a stock with very limited downside, but fairly significant upside, exactly the type of trade that I look for.

Most of what you're saying makes perfect sense to me but....

by your logic, wouldn't BBRY be much better?

- Much much cheaper. In fact, doesn't the valuation of BBRY indicate there's potential downside to AAPL?

- Better downside protection

- More upside potential

Apple probably includes me among the millions of people with an iTunes account. In fact, they'll probably count me three times in their statistics. They earn precisely nothing from those accounts.

I also happen to have one blackberry account. BBRY sure collects a heap of high-margin revenue from that account.
portfolio14
Portfolio14 - 1 year ago
Hi Batbeer2,

I think you are onto something.

BBRY is a turnaround that has almost turned with downside protected by its balance sheet; AAPL is a cashflow machine with many optionality not priced in. I suppose different investors have different preferences for different investment theses.

For the record, I long both AAPL and BBRY.

p.s. At the end, I can't get myself comfortable enough to buy PostNL. Btw, I think their retail strategy is wrong, completely backwards. Look at Australia Post (not listed but has financials published on their website). Their retail franchise contributes significantly to its bottom line.
varunfriend
Varunfriend premium member - 1 year ago


It all depends on how one invests .. if the approach is to diversify then the more stocks with such optionality built in the better, you cant be sure which one will work but expect more of them to work than not.

If running a concentrated portfolio then technology risk is probably too high in both AAPL and BBRY.

Ps: I was long bbry around 8 and sold around 13 .. and I am now long AAPL. Needless to say I dont have a very concentrated portfolio.
swnyc2
Swnyc2 - 1 year ago
Hi Batbeer2,

Nice comparison, although I draw a different conclusion.

Looking purely at the accounting, there's no question that BBRY is a much cheaper stock -- today.

However, with regard to assessing risk, I like to ask which stock would you rather own if you couldn't sell it for at least 10 years?

BBRY, while cheap now, is much less likely to be a going concern 10 years from now. They face some stiff competition from AAPL, Android, and Windows. While it may be bought out, there's no telling how long that will take -- and how much of the value will be left.

There is risk with AAPL as well. It remains to be seen to what extent AAPL will face increasing competition and to what extent it will develop new products. Nevertheless, there is a good chance it will be doing reasonably well 10 years from now.

Based on this "gut check" I would actually favor AAPL over BBRY despite the fact that BBRY is much cheaper today.

As Buffet says, I think one will do better in the long run choosing wonderful companies at fair prices, rather than fair companies at wonderful prices....

batbeer2
Batbeer2 premium member - 1 year ago
>> BBRY, while cheap now, is much less likely to be a going concern 10 years from now.

I own neither for that reason. I expect both to be around in 2025, I just don't know what they'll be doing. If I had to pick one I'd pick BBRY though. I like the QNX part of the business. They're very big in cars already. I expect cars to get much more "intelligent" by 2025 and BBRY has a very good chance of taking a chunk of that business.

>> At the end, I can't get myself comfortable enough to buy PostNL. Btw, I think their retail strategy is wrong, completely backwards.

Hmm..... good point. Oesterreicjische Post also generates revenue from their "retail" network. PostNL is closing a lot of their service points and I think it's dumb.

I think you should consider buying it though. In my experience the mere fact that I don't own a stock is a very strong catalyst :o)
swnyc2
Swnyc2 - 1 year ago
I didn't know about QNX. It's been some interesting reading.

Thank you for the education -- again!
batbeer2
Batbeer2 premium member - 1 year ago
Remember the playbook?

That device wasn't a commercial success but no one was blaming the stability or connectivity of the OS. In fact, those were its strongpoints.

That same OS lives on in a significant percentage of new cars. If memory serves, more than 5% of newly produced cars are basically playbooks with wheels and engines. I can see how in 10 years, if you want to sell your 3 year old old car, you are going download some flashy "apps" or features from BBRY to make it sell better.
portfolio14
Portfolio14 - 1 year ago
>> BBRY, while cheap now, is much less likely to be a going concern 10 years from now.

I think people don't appreciate what Whitman called "resource conversion" and the asymmetry in the risk/reward. If it survives as a going concern, it'll be a multiple bagger. But even if it doesn't and is sold off in pieces, you may not get back $14 completely, it'll be close. "Head I win, tail I don't lose much." Apparently, the resource conversion thesis was a no-brainer when BBRY was at $7. Now, it's merely a downside protection.

>> I like the QNX part of the business. They're very big in cars already.

But the QNX side of the business can't support its current market cap. I consider this icing on the cake. Besides, Apple is entering this space.

batbeer2
Batbeer2 premium member - 1 year ago
>> But the QNX side of the business can't support its current market cap. I consider this icing on the cake. Besides, Apple is entering this space.

Yeah... QNX isn't worth 7B today. But I think it's a valuable asset and it could become very valuable.

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