Apple's (AAPL) stock perked up this morning on news that the company has trademarked the term "iWatch" in Japan.
This reminded everyone that, at some point, Apple will finally come out with a new product, one that might get investors excited about the company again.
A Wall Street Journal story also reminded everyone that the company still might yet cut a deal with the massive Chinese mobile juggernaut China Mobile, which would make the iPhone available to China Mobile's 700 million (!) subscribers.
And there's always the hope that Apple will eventually launch a much-anticipated television set.
Any of these events would be helpful for the stock.
But, for the moment, Wall Street has basically given up on Apple.
The stock has tanked more than 40% from a peak of $702 last September to a recent low of about ~$390.
Apple's stock has gotten so hammered that it's now trading at a price/earnings ratio of about 10X.
That P/E ratio is well below the market average, which is about 15X. It is also a valuation so low that it is generally awarded only to companies that Wall Street thinks are permanently screwed. See Dell (DELL), BlackBerry (BBRY), or Hewlett Packard (HPQ).
Apple also has ~$150 billion of cash and no debt, which means that the market's assessment of Apple's actual business is even more pessimistic. (If you buy the stock, you get the $150 billion of cash along with the company). Apple is also already paying a dividend of 3%.
To be sure, much of the pessimism around Apple is justified. The case against the company is very easy to make right now:
- The company's growth has vanished: Earnings are expected to shrink this year.
- The company's critical product, the iPhone, has lost its edge, and the product cycle that drove Apple's mind-boggling profitability over the last several years (premium smartphone growth) is nearing its end.
- Apple's profit margin is dropping, as its main products get commoditized.
- Apple is no longer led by a legendary product visionary, and the CEO, Tim Cook, has not articulated a vision of where he wants to take Apple going forward.
- No one knows if Apple has any truly great new products in the pipeline.
- Apple has cash coming out of its ears, but no clue what do with it.
All of those points are legitimate. And it's possible that Apple is indeed in the early stages of a long-term decline.
(Such declines happen frequently in the tech industry — think Nokia (NOK), BlackBerry, Microsoft (MSFT), Digital Equipment Corporation, Yahoo (YHOO), and Apple in the 1990s, to name just a few. To think that this can't happen to Apple would be the height of reality distortion.)
Buried in this heap of terrible news is some good news: Wall Street has now become so pessimistic about Apple that it's possible that investors will be positively surprised going forward.
At this valuation, Apple really does have to be in the early stages of an inexorable long-term decline for the stock not to provide a reasonable return.
How do we know?
Because, in the last fiscal year (ending in September), Apple generated more than $40 billion of cash.
At that rate of cash generation, it would take Apple only six years to earn enough cash to equal the value that Wall Street is currently placing on its entire business ($240 billion).
In other words, if you were able to buy all of Apple today for the current market price of ~$390 billion, you would be able to pocket the company's $150 billion of cash. Then, if the company's cash generation remained the same, you would only have to wait six years before you got back ALL of the cash you used to buy the company. Then you would own Apple's business free and clear, for nothing.
What this tells you is that, at the current stock price, Wall Street is assuming that Apple won't generate anywhere near $40 billion of cash a year going forward. (If Wall Street did assume this, then every Warren Buffett-like "value" manager in the world would be loading up on the stock.)
The stock's current price, in fact, suggests that Wall Street thinks that Apple's cash generation will collapse going forward.
And it very well might.
Thanks to the competitive dynamics in the global hardware business, and Apple's need to both reduce prices on its current products and launch lower-priced products, Apple's profit margin will likely drop sharply in the future.
The markets that Apple is selling into — global smartphones and tablets — should continue to grow. So, if Apple does launch lower-priced products to remain competitive, Apple's overall revenue should continue to grow.
And here's the key point: Even if Apple's profit margin gets cut in half, and even if the company's revenue never grows again, Apple will still generate enough cash to pay back investors in 12-13 years for buying the business today.
That's how cheap the stock has gotten.
Even if Apple's cash generation falls to $20 billion a year from $40 billion, which would be close to a disaster, Apple should still generate $250 billion of cash over the next dozen years. Add that to the $150 billion of cash the company already has, and the investment will have entirely paid for itself within 10-15 years.
In other words, to believe that Apple's stock is worth even less than the current market price, you basically have to think that the company is becoming Nokia.
Disclosure: A few months ago, when Apple stock crashed to $390, I took the plunge and bought it. I firmly believe that index funds are by far the best investment strategy for individuals, and that's mostly what I own. But, very occasionally, when the mood strikes, I make bets on single stocks. I have no special insight into Apple, and it would not shock me if the stock plunged even further. But at least, for a while, I'll be collecting a nice, fat dividend.
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