By Martin Tillier
Sometimes the market makes me laugh. I have frequently said that traders are professional over-reactors and, at times, price action seems bound and determined to prove me right. Take Apple (AAPL) for example. Back in August, when I dared to question the upward surge of the mighty AAPL, I was decried as a heretic. Didn’t I know that they were infallible? Wasn’t it obvious that exponential growth would continue forever? Weren’t analysts falling over themselves to issue ever higher price targets? All I had was a trader’s instinct, and what possible use could that be in the face of such collective certainty?
It is a simple market truism that everything looks most bid at the top and offered at the bottom. Thus, as all of the worms begin turning, it is hard not to feel that we are approaching the bottom. Sure, I understand increased competition in the tablet market. I get that the latest remodeling of the iPhone has raised some questions. I saw Nokia’s (NOK) failed venture into the TV market during the 90s, so I remain skeptical of that idea. But, just as not everything was perfect as AAPL crashed through $700, so not everything is doom and gloom now we are going back through $500.
Fundamental analysis is generally a good thing, but much of it has its flaws. A personal favorite is forward P/E. In the case of a rapidly growing company such as AAPL, it is particularly useless. Throughout the last couple of years, the company has consistently beaten estimates for revenue and EPS. To put it another way, the analysts have got the” forward” part of that equation wrong. Forward EPS can be a useful tool, but to base investment decisions on it when nobody has a clue what earnings will be seems unwise at best. So, let’s take out the guessing part and look at historical earnings. In FY 2012 Apple made $44.15 per share. At the current levels around $500 this translates to a Price to Earnings ratio (P/E) of around 11.3. In order for this not to appear cheap, you have to believe that Apple’s earnings are about to not just stop growing so fast, but actually decline. Given this morning’s announcement of record sales of the iPhone 5 in China, do you really believe that?
When sentiment turns on a stock, for whatever reason, one of the two enemies of investors, either fear or greed, takes over. In the case of AAPL, at the top every piece of good news was exaggerated and every piece of potentially bad news was ignored. Now we are at the opposite end of the spectrum. Those great initial Chinese sales numbers for the iPhone 5 are being overshadowed by a downgrade to neutral from Citi. It becomes apparent how ridiculous that is when you consider that the downgrade is accompanied by a new price target of $575. Ignoring the reality of actual sales and focusing only on the bad news still tells us that the stock is undervalued by 15%!
I believe the selling of Apple started as people began to realize that four figure short-term price targets were overdone and expectations of ever greater growth were unsustainable. Fuel was added to the fire when many long term holders decided to take their significant capital gains while they were still subject to a 15% tax rate. These were both good reasons to sell, and the correction was inevitable. A lower pre-market price today, however, tells me that we have reached the next stage. When good news is ignored and the mildly bad is exaggerated it is time to deploy the Buffet strategy. Others are fearful. It may be time to get greedy.
Martin Tillier has been dragged, kicking and screaming, into the 21st century and can now be followed on Twitter @MartinTillier.