What makes stocks go up and down? My best bet is that stocks rise when companies deliver better-than-expected earnings and raise their growth forecast each quarter.
A more traditional approach — growth at a reasonable price — suggests you should buy a stock when its price-earnings ratio is lower than its long-term earnings growth rate. Although that has been a good strategy over decades, according to the CFA Institute, a recent Bank of America survey found that growth-oriented portfolios have outperformed value-based ones over the last five year
Another way to look at this is that prices rise and fall because new money follows older money. More specifically, packs of investors follow the lead of gurus like Warren Buffet — sending enormous pools of capital flowing into and out of stocks. Sadly, the split second flows of capital into or out of particular stocks, driven by computer-based trading, seem to defy analysis.
This comes to mind in considering shares of Apple — which soared 86% in 2019. (I have no financial interest in the securities mentioned in this post). Why have its shares gone up? It set very low expectations for growth and exceeded them. What’s more, investors have concluded that better times are ahead.
However, until Apple’s price drops 59% or earnings growth expectations rise, I think its stock will offer investors a chance at going up because other people are buying the stock — rather than because it offers a chance to own growth at a reasonable price.
Why Apple Is Not a Growth Company
Apple has been getting smaller thanks to a continued decline in its iPhone sales (9% below the year before). On October 30, Apple reported that profit shrank for the fourth consecutive quarter — 3.1% in the fourth quarter alone, according to the New York Times— while revenue for the quarter rose a mere 1.8% to $64 billion.
However, Apple exceeded expectations and raised its guidance for the holiday quarter. To be sure, the bad news about its China sales — which fell about 20% in the previous nine months — was a less bad 2.4% decline in the September-ending quarter. Apple also predicted holiday quarter revenue in the range of $85.5 billion to $89.5 billion — the midpoint of which is 4% more than the previous year’s $84.3 billion.
Apple’s marketing genius in 2019 was harnessed not to develop a compelling new product but to convince investors that the company would get smaller. Tom Forte, an analyst at D.A. Davidson, told the Times that “The company is still benefiting from low expectations [set in January]…when they set the bar really low. And since then, they’ve been telling a different story, which is that they’re pivoting to be less dependent on the iPhone.”
In addition to what analysts see as good news in China, they forecast strong iPhone demand due to a price drop in its flagship version and the addition of another camera to its higher-end models. Meanwhile, growth in wearable devices such as the Apple Watch and AirPods — up 54% to $6.5 billion and services — which rose 18% to $12.5 billion — partially offset declining iPhone sales.
Sadly for investors hoping that Apple can grow its revenue at double-digit rates, wearables (at 10% of total revenues) and services (20%) are too small to make a significant dent in its low-single-digit top-line growth.
Why Apple Is Not a Value Stock
One way to decide whether Apple shares offer growth at a reasonable price is to calculate its PEG ratio — the result of dividing its price-earnings ratio by its long-term earnings growth rate. If a company’s PEG is 1.0 or below, it offers investors an opportunity to buy growth at a reasonable price.
By that logic, Apple shares are considerably 0vervalued. After all, its PEG is 2.5 — based on a price-earnings ratio of about 24.7, according to Morningstar— and some 30 analysts’ average forecast of 9.9% annual five year earnings growth for Apple, according to YahooFinance.
One Apple analyst believes that Apple shares are grossly undervalued. Loup Ventures analyst Gene Munster thinks Apple is worth between $350 and $400 a share thinks to continued growth in wearables and excitement over 5G iPhones to be introduced in the second half of 2020, according to Bloomberg.
Rather than becoming less dependent on the iPhone as Forte said was its future, Munster — Bloomberg’s most optimistic Apple analyst — sees iPhone 5G upgrades as Apple’s “biggest iPhone upgrade cycle” since 2015 — resulting in two years of 10% iPhone revenue growth.
A less bullish Apple analyst, Paul Meeks, said December 31 that Apple should drop 40%, according to CNBC. Meeks argued that the iPhone continues to deteriorate and investors are too excited about Apple’s transition to a software as a services company.
Will Apple Stock Rise Another 36%?
If Munster is right, Apple stock could rise another 36% over the next couple of years. However, when Apple reports the results of its holiday quarter, the key driver of its stock price performance is likely to be whether it can exceed its 4% revenue growth target for the quarter and boost its forecast.
Such measly growth is not enough to justify its current PEG ratio — let alone the even higher valuation implied by Munster’s $400 price target. If Apple stock fell 59% to $122 it would trade at a price-earnings ratio of 10 — roughly equal to its five year earnings growth rate.