Apple is already choosing its battles and, in fact, does not need to win all of them. Unlike many potential growth bets, Apple does not need miracles in order to ascend into investment paradise. In our view, conservative investors should be interested in Apple just as much as growth investors, if not more interested. Why?
The iPhone is a margin beast. As we noted elsewhere, the iPhone is a 49 percent margin product, compared to 23 to 32 percent for the iPad; the iPhone is a dream product in that regard. The iPhone 5 sold 5 million units since its launch last Friday, but this was not as high as the most bullish estimates of 6 million to 10 million units. We are not very concerned about this alleged shortfall. Merrill Lynch analyst Scott Craig, who has pegged a $850 price target on Apple Inc (NASDAQ:AAPL), noted that supply limitations were the primary reason for the disappointment. When taking into account the September 29 second-wave roll out of the iPhone, Craig thinks that every 1 million iPhones sold translates into an additional $0.15 earnings per share.
Apple is number one in notebooks. Apple has the privilege of both jeopardizing the future for the notebook market with the iPad while, at the same time, monopolizing the notebook market. Sure, the company sold 17 million iPads in the second quarter, more than any other company sold of its entire lineup. Its tablet market share increased to 68 percent from 62 percent last year. Aside from that, though, Apple’s notebook is first in respect to present sales. Additionally, Apple Inc (NASDAQ:AAPL) does a good job of giving its customers ways to connect tablet, mobile, and notebook devices, increasing the likelihood that consumers will want two or all three.
Hedge funds love it. Apple was the most popular holding for hedge funds during the second quarter (view them all here). We think that by tracking the best picks of the most successful hedge funds, one can make more informed investment decisions. Indeed, hedge fund managers Philippe Laffont and David Einhorn both think the shares belong in $1000+ land. Einhorn, who has had an apple position for a couple of years, noted that Apple is “very, very substantially undervalued” back in July and that it is “the best growth company we have.”
Apple and Google are complementary value plays. We think that Google Inc (NASDAQ:GOOG) and Apple are, above all, value plays—something that many people ignore. Priced at 15 and 12.5 times forward earnings, respectively, Google and Apple are value stocks with exceptional growth potential. Unlike Google, Apple does not generate revenue via per-click advertising like other tech companies. Though we view Google’s valuation as very attractive, Google shares have increased 30 percent since the beginning of summer, tightening the pure margin-of-safety argument. Google is “the best advertising product in the history of mankind,” says one commentator, who also notes that the iPhone is the most “profitable product in the world.” These are, fundamentally, two different markets, so we do not think value investors need to choose one or the other.
Apple has easy-to-understand and tested sources of growth. This makes Apple Inc (NASDAQ:AAPL) the anti-Facebook Inc (NASDAQ:FB). Facebook CEO Mark Zuckerberg has realized that Facebook is a “mobile company,” but it is unclear how. According to a recent poll of mobile developers, an impressive 66 percent believed that a mobile-first social networking start-up could put the kibosh on Zuckerberg’s predictions. In contrast, it is not even clear what a “lethal” product or start-up would look like in Apple’s case. Apple is a maturing company with significant growth prospects and a loyal (at times fanatical) customer base.
The value story makes the growth story even better. If we take analyst consensus growth estimates as an indicator, Apple’s present valuation does not account for its growth potential. The price/earnings to growth (PEG) ratio helps us to see whether a company’s valuation reflects its earnings growth potential. Ideally, after dividing P/E by the 5-year anticipated growth rate, we should come up with a value close to one, and the lower the better. Apple’s PEG is at 0.7, whereas Google’s is at 1.2. Assuming that growth projections are not off base, this means that we can take a bigger slice of the growth pie with Apple shares as opposed to Google shares at present share price levels.
Apple has a backdoor into the enterprise space. Apple Inc (NASDAQ:AAPL) is not making it a point, as Hewlett-Packard Company (NYSE:HPQ) is attempting to articulate, of “solving customer’s problems.” Apple is not going to clean dust out of server rooms or address logistical issues at the enterprise level; Apple makes end-user products. Apple’s approach is more of a “bring your own device” approach, notes Jonny Evans of Computerworld.com. About 96 percent of companies report owning at least one iPad, and many organizations dual-boot Windows on Apple computers. Microsoft Corporation’s (NASDAQ:MSFT) Windows 8 is poised to be a major competitor for Apple in the enterprise space. However, as Intel Corporation (NASDAQ:INTC) CEO Paul Otellini noted in a staff memo this week, Windows 8 still has its share of bugs. In the absence of excellent execution on the part of Microsoft, Apple will be a default choice for end users many in the enterprise space.
At the end of the day, Apple has a clear-cut business that is very profitable. During the spring, many were hailing Apple CEO Tim Cook as the next Steve Jobs. After the recent down-tick from the iPhone 5 launch, many are quick to blame him for a lack of ingenuity, foresight, and the like. We do not view this alleged “lack of innovation” as a rational source of investment anxiety. Tech geeks (including the author) still praise the company for innovation. The iPhone 5, remarks esteemed technology website CNet.com, is “the iPhone we’ve always wanted.” Tech super-geeks at Ars Technica subjected the 15-inch Retina MacBook to benchmark tests and “came away impressed.”
In reality, though, this set of praise for innovation is icing on the valuation story cake. There are many options in the smart phone space, so it would be foolish to proclaim that Apple will forever be a leader in the space or that its stock will double every three years because of it. However, given the growth expected in the smart phone market and the company’s bargain valuation, we remain optimistic about Apple.
Disclosure: Brian is long Apple Inc (NASDAQ:AAPL) and Microsoft Corporation (NASDAQ:MSFT).
