Why Apple is a buy

Apple is on sale. And it’s not the iPhone 5 or iPad Mini either. Rather, it’s the company itself. Since the release of the much anticipated iPhone 5 in September, Apple’s share price has tumbled over 20 per cent, from all time highs of $US705 to a six month low of $US533. While this sharp decline may reflect growing levels of investor uncertainty around the company’s future, many industry pundits believe the sell off is an outstanding buying opportunity. Much of this bullishness stems from Apple’s outstanding financials. But in an industry with constantly changing dynamics, relying on just great financials is not a guarantee future success. Great vision, constant innovation and excellent execution are among the factors that may help Apple maintain a high level of success.

Apple shares, like its products, are worth buying if you believe all the hype. The recent 20 per cent decline in Apple’s share price has highlighted a few reasons why investors should be wary, despite the company’s excellent underlying fundamentals. For one, the world’s greatest investor, Warren Buffett, won’t go anywhere near technology companies, especially Apple. Buffett invests in companies with predictable business models in industries where customers have predictable needs and wants. The tablet and smart phone market is far from predictable. Who knows what could come along in the next one to two years?

A perfect example of the unpredictability of the technology industry is the Blackberry maker Research in Motion (RivSec: RIMM). One year it’s the benchmark of mobile communications, the next the majority of its products are largely redundant. In Apple’s case, one bad product launch or a disruptive technology from an unknown competitor could spell disaster. While it could be argued that Apple is the next IBM, with its narrow product mix and Steve Jobs’ grand vision no longer leading the company, risks of a hiccup are now far greater. Despite all the risks, Apple’s breathtaking financials should help soften the blow of future hiccups.

As a standalone company, Apple has some of the best financials going around, especially given the tough economic environment. When compared to other technology companies, Apple is a clear standout. The average trailing P/E ratio of technology companies listed on Wall Street sits at a lofty 22 times, while Apple commands a P/E ratio of only 12. On top of this, it pays a healthy 2 per cent dividend yield, has $US120 billion in cash, excellent YoY revenue and profit margin growth, and management is achieving a 42 per cent annual return on shareholder funds. In comparison, the other tech darling Google has an average P/E ratio of 20, no dividend, and slowing revenue and margin growth. And this is just for starters.

Compared to other well known Nasdaq listed companies, Apple looks cheap, very cheap. The average trailing P/E ratio of companies listed on the Nasdaq 100 index is 24.52. Few companies come close to matching Apple’s financial strength, yet investors are more willing to pay far more for sub average technology companies. Look no further than Amazon, with its share price mostly driven by lofty future expectations, as it commands a ridiculous 427 trailing P/E ratio. Despite missing earnings and a lofty valuation, Amazon is down only -2.82 per cent amid broader market weakness, whereas Apple has plunged -14.06 per cent.

Apple’s outstanding financials clearly have not been reflected in share price performance over the past three months. Given Apple is essentially the same company it was three months ago, recent weakness in its share price could be a great buying opportunity for investors and traders with a short to medium term time horizon. So unless we see some real change to Apple’s fundamentals near-term and broader market weakness dissipates, there is a strong case for Apple’s share price to rally back toward all time highs above $US700. Longer term, however, the fast paced nature of the technology industry makes it very difficult to predict the future prospects of the world’s largest company.

 

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