Apple Inc., a Stock Analysis for December 2010 – Buy a Bushel Basket of Apple Stock

“A diet is a short period of starvation preceding a gain of 5 pounds” – from “The Best of the Good Clean Jokes” by Bob Phillips

Bearish Apple Inc. stock traders were disappointed by the 2010 third-quarter earnings report from Apple.  They contend that Apple has gotten too big.  There are no new significant income streams.  iPhone sales are down.  iPad sales were not as good as they could be.  iPod sales were off.  Competitors are jumping in from every side on all their products.  Apple is going to languish because of this.  Finally, as proof they cite two quarters of reduced revenue.  To be sure, there is at least some truth in all of these points.  Nevertheless, Apple is getting ready to put on some major weight in terms of profits.  This is a very timely moment to buy into Apple’s stock as we shall see.

First, I shall share an important point of bullish investment philosophy.  Bears often times look for perfection.  If there are significant challenges to a corporation or enterprise, and there is no immediate foreseen solution, then they expect failure.  Bears often miss the point that there is no human organization that is ever perfect.  Corporations and enterprises will always have challenges.  The best corporations and enterprises know how to manage the challenges and be successful anyway.  I believe this is especially true of Apple Inc.

Apples Revenue History

Let us first take a look at Apple’s revenue for the last three years – not just the last three quarters.

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Let us first notice that in the third-quarter of 2008 Apple’s total revenue was $7.561 billion.  In the third quarter of 2010, Apple’s revenue was $15.7 billion.  They have doubled their revenue in the space of two years.  That is a feat that very few companies of Apple’s size can match – although most companies long to do so.

Now let us take a look at the graph for some patterns.  Notice how Apple has a large pop in revenue either in the fourth quarter or the first quarter of every year.  This makes complete sense because of US Christmas holiday shopping patterns and students buying computers for school.  Apple is not alone in this.  Statistically for many-many decades, the fourth quarter is the best quarter for the average public corporation.  A drop in revenue from the first-quarter to the second quarter and then to the third-quarter is quite normal.

But wait, the third-quarter of 2010 was actually a little bit higher than the first quarter – $15.7 billion compared to $15.683 billion.  This is what is significant.  Apple had a fantastic third-quarter when you compare it to other third-quarters they had before!  Finally, notice the general upward trend in the revenue graph.  Sure revenue varies from quarter to quarter and that is normal for corporations.  Revenues do not go up in straight lines – even for Apple.  But when you draw a line through the mean revenue, the revenue trends are very exciting.

Just imagine what the fourth quarter or the first quarter of 2011 is going to be like for Apple after the holiday season.  Already, meaningful shopping statistics are in after the 2010 Thanksgiving weekend.  Retail sales are much higher for 2010 than they were in 2009.  Apple is selling very desirable consumer products.  Apple will take a significant share of holiday shopping money and post record revenue totals in this timeframe.  Revenue of $18-$19 billion would be consistent with the mean trend for the first quarter of 2011.  We can even dare to dream $20 billion or more!  A smart investor would buy Apple now, before 2010 fourth-quarter and 2011 first-quarter revenue totals are out.  This makes Apple a great short-term value play for the next couple of quarters.

Unit Sales

iPhone

Apple-iphone4.jpgApple iPhone sales reached nearly 8.4 million handsets in the third-quarter 2010.  This was a 61% increase over the same quarter in 2009.  The  latest Apple iPhone is iPhone 4.  This new model was launched late in the third quarter of 2010.  Sales of this unit are not fully baked into the figures.  Early indications from Apple are that this product launch was hugely successful.  1.7 million iPhones were sold in the third quarter of 2010.  Apple characterized this as one of the most successful product launches in history.  Because there is not a long history of iPhone sales, it is risky to forecast a negative trend for iPhone sales with such a small drop in unit sales from the second quarter to the third.  Take a look into the next chart.

It is technically true that the third-quarter trended lower than the first and second quarters for iPhone sales.  However when you look at the total numbers, this downward trend is not terribly significant.  Remember, the third-quarter for Apple is historically weak.  This is not at all unusual for a public corporation.  Reading too much into a third-quarter drop in performance is a classic investor mistake.  I look at seasonal factors and other data before I draw the same conclusion.

A more likely explanation for the downtrend in iPhones was the rumor of the new iPhone 4 cannibalizing iPhone 3 sales and a serious difficulty in keeping up with manufacturing supply.  This was combined with the typical seasonally lower third-quarter consumer demands.  Further, Apple had to delay the launch of the white iPhone 4.  For a time, Apple made customers wait for three weeks before receiving a phone.  More than likely, Apple’s internal estimation of unit sales was too low.  Their manufacturing supply chain was not prepared to keep up with demand.

Drawing from the lesson learned from the total revenue graph, we can come to an optimistic conclusion about iPhone sales.  Because 2010 third-quarter figures were comparable to first and second quarters, you can rightly argue that iPhone sales are actually seasonally high and this bodes well for the next couple of quarters. Apple-2010Q3-iphone-unit-sales-600.png

There is more to the iPhone profitability than just iPhone sales themselves.  Apple makes a significant amount of money on software applications and entertainment media like music that is downloaded into the iPhone.  Profits from the iPhone therefore are not a one-time event but rather they reoccur throughout the life of the product.  For instance Apple’s music sales in the second quarter of 2010, was nearly $5 billion.  This is a significant chunk of the company’s revenue.  Apple also makes money on advertising on the iPhone and the sale of software applications as well.

There is even more to the iPhone story than this.  Shaw Wu from the respected Kaufman Brothers, expects 62 million iPhone sales in 2011.  8,000,000 to 12,000,000 new units shall come from the new Verizon cell phone network capable iPhone.  This by itself should add 5% to 10% to Apple’s earnings per share.  He goes on to write that he does not see the BlackBerry 6, available on Verizon’s network, as eating significantly into iPhone sales.

Apple shall continue to have AT&T as their provider as well as Verizon.  Expanding to the Verizon network could not come at a more appropriate time.  Recently, Consumer Reports stated that the AT&T cell phone network is the worst rated cell phone network for customer satisfaction.  Undoubtedly, many consumers have been waiting to purchase iPhones until they were available on another cell phone network.  This should also drive up iPhone sales significantly.

What about iPhone competition?  Analyst writing for the Wall Street Journal, say that Apple is fully aware of competition from other telephone manufacturers, such as Google’s Android.  They conclude that Apple is going to create a new smaller screen iPhone to capture the low-end market and Apple will likely put the iPhone features into the iPad.  In fact, the iPad already has AT&T’s 3G-network technology.  This larger screen iPad/iPhone shall become the top end of the line.

While these rumors are unsubstantiated by Apple, you can bet that Apple is working extremely hard to innovate new features into the iPhone and they are not going to wait for their competition to develop new features first.  Apple has a history of developing innovative and high-quality products that exceed consumer expectations.   It is certain the iPhone shall continue this tradition of innovation.  Apple is a year ahead of any other competitors in the smart phone market place.  Most analysts agree that Apple should keep its edge through 2011.

iPad

Apple-iPad.jpgRelative to the iPhone, the iPad is the new kid in town.  Apple already has three models of notebook computers, the MacBook, MacBook Pro and MacBook Air.  All of these laptops have keyboards with a fold up screen.  The iPad is different.  The iPad does not have a fold up top or a keyboard.  Keyboards can be plugged into the USB port as an option.  However, most people see the iPad is a new type of computer called a tablet computer.  Because of the newness of the iPad, it is difficult to forecast sales based on history.  That does not mean we can come to some favorable conclusions for Apple and the iPad.

To be sure the iPad is one of the most successful new products in years.  Apple initially projected building 7.1 million units for 2010.  This is according to the analysts at iSuppli.  iSuppli is a respected analyst of technology companies.  Now, iSuppli sees Apple producing 12.9 million iPads for 2010, 36.5 million units for 2011 and 50.4 million units for 2012.  This is phenomenal growth for a new product.  This is especially exciting when you realize Apple’s executives state that more money shall be made on the iPads by selling advertising space, applications, music and video media, then the units themselves.

iSuppli projects the sales based on increased production of NAND memory chips used by the iPad and iPad sized LCD screens.  They go on to say that Apple plans on adding new features to the iPad, like a camera and larger screen sizes.  They state that Apple currently has 84% of the tablet market and they expect Apple to maintain this market share through 2011.

I assume a $660 price tag for the typical iPad sale and a 21.5% profit margin that is typical for Apple.  Just with iPad sales alone, this represents nearly $3.4 billion in additional profits for Apple in 2011.  Remember this does not even include software and media sales!  Take a look at the gross revenue plots above and tell me now you are not excited.  Just on iPad sales alone, Apple can continue the revenue growth trend line for 2011!

Other Points and Conclusion

In addition to iPhones and iPads, Apple has a complete line of PCs, laptops and their ever-famous music iPod.  Gartner, a highly respected market forecasting company, predicts that PC sales shall continue to climb in 2011, compared to 2010.  This fits with other economic forecasts.  The consensus economic forecast for 2011 is for the US GDP to grow 3.3% annually.  This compares to the projected 2010 growth of 2.5%.  Apple has been selling well, even in a challenging 2010 economy.  Just picture what Apple will do when the economy returns closer to normal.

Because of Apple’s success, Apple has very little debt.  Value Line rates their finances as A++.  They sit on a cash reserve of billions of dollars.  They have so much cash in fact that seemingly crazy rumors are circulating.  The Wall Street Journal reported that Apple is contemplating a huge takeover sometime over the next year.  It is speculated that Apple may buy Adobe, Disney or even Sony.  The last two choices make a great deal of sense because this gives Apple access to music and video media.  Who knows what Apple will finally do with their war chest of money.  However, Apple will probably do something very bold over the course of 2011.  This will add further excitement to their stock in price appreciation.

Apple just reached a 52-week high at over $320 a share on December 6, 2010.  I have had many investors ask me is not Apple’s share price too high?  Yes, I admit the share price is intimidating.  However, most brokerages do not charge extra for buying small odd lots of Apple shares.  What is more important for investment value is what is Apple’s price to earnings ratio.  Apple’s trailing PE was 21.13 on December 6, 2010.  Considering Apple’s explosive growth and the fact that PE data looks backwards in time for six months to a year, Apple is very reasonably priced.  For comparison on the same date, Apple’s PE was lower than Google’s!  From that point of view, Apple is a better buy.

Apple share price has grown over 65% year-over-year.  Just with the iPad and iPhone sales alone, Apple shall make incredible profits for 2011.  Throw in Apple’s other computers, laptops, new OS, mobile software applications, entertainment media and they are set to achieve record growth again for 2011.  Bring in a healthier 2011 US economy and this shall turbo charge Apple’s profits further.  In addition, because of Apple’s recent stock price lull, they offer a good value play for the next couple of quarters too.

Prediction

“If you’re such a good fortuneteller, you should be able to tell me the score of tonight’s hockey game before it starts!”

“Before the game starts, the score will be nothing to nothing!” ‘ – from “The Best of the Good Cleaned Jokes” by Bob Phillips

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