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At this price, Apple is too tempting
Investors knocked 10% off the iPod maker's stock after Apple's earnings disappointed Wall Street. But management continues to deliver fast growth and faster innovation -- such as the new video iPod -- so it's time to buy.
By Robert Walberg
Most companies would kill to emulate Apple Computer's recent success.
Last quarter alone, Apple (AAPL, news, msgs) shipped a staggering 6.5 million iPods -- up from about 2 million during the same period last year. iPod revenues surged by 125% year-over-year to $1.21 billion.
Yet it was Apple's stock that got killed. After the company announced those results Tuesday, the stock fell 10% in after-hours trading. Just another example of how reality and Wall Street expectations often clash. You see, shipping 6.5 million units wasnt good enough. At least one analyst from a respected Wall Street firm was expecting the company to move 8.5 million iPods -- quadruple last years number.
Did it matter that the forecast was nowhere near Apple's guidance? Nope. What mattered to investors was that Apples results no longer blew away even the most optimistic of forecasts. iPod mania, Wall Street's best and brightest assume, is at its end.
Waiting for the next iPod
Pure nonsense. Apple controls over 75% of the digital jukebox market and, despite intense competition, that share is growing. Given the sheer volume of iPod sales, its totally unrealistic to expect sales to triple or quadruple quarter in and quarter out. Sales growth of 125% at this stage of the product cycle is extremely impressive.
Whats more, Apples goal of growing once-stagnant computer sales on the back of the iPod craze appears to be coming to fruition. The company shipped 1.236 million Macs in the quarter, slightly ahead of the consensus estimate of 1.21 million. Revenues for the PC business jumped an impressive 31%, to $1.61 billion. Apples share of the computer market remains miniscule, but it is at least trending in a positive direction for a change.
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Here's what investors want to know, though: What's next? If iPod sales must inevitably slow, what's the next big thing that will drive double-digit sales and earnings growth.
Apple's recently announced partnership with Motorola Inc. (MOT, news, msgs) to produce an iPod cell phone generated little excitement. A day after Apple announced its earnings, Steve Jobs, chief executive and chief buzz-master, unveiled a new video iPod and a new iMac equipped with a remote control at a meeting in Silicon Valley. The company is also expected to announce that it will begin selling music videos at its online iTunes store.
Forbidden fruit no more
Its doubtful the new video iPod will generate sales equal to the music player, but underestimating Apple recently has not been a good idea. I should know, as I wrote in this space a year ago that the stock was overvalued.
Based on the huge and growing success of its iPod franchise, and the steady progress in its computer business, Apple shares deserve a premium price-to-earnings multiple. At 30 times estimated 2006 fiscal-year earnings of $1.71, the stock might seem expensive, but remember the company also has nearly $9 a share in cash.
Backing out that cash, the stock trades at 25 times estimated earnings. Admittedly, thats still a premium to the rest of the computer industry, but no other company in the group comes close to matching Apples growth potential. It should also be noted that Apple generated more than $1 billion in free cash flow over the last year, with a return on equity of more than 17%.
There arent many companies operating with such success in todays difficult environment. So while the rest of the Street frets over Apples lackluster performance, savvy investors will take advantage of Apple's lower stock price to buy in or buy again.
At the time of publication, Robert Walberg did not own or control shares of companies mentioned in this column.
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