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Can Apple Shares Stay Fruitful?

Few stocks this year come with the bragging rights of Apple Computer (AAPL). In the past year, it has skyrocketed from $17 to $46 -- a 170% gain.

Fueled by the success of the iPod digital music player, sales for the 2005 fiscal year, ending in September, are likely to come in at $3.9 billion, about 70% higher than last year, according to analysts' consensus estimates from Thomson Financial. Even better: Earnings per share for that time are expected to have grown nearly 300% -- from 36 cents a share to $1.42.

HARD ACT TO FOLLOW. Given that remarkable growth, it's tempting to rush out and buy Apple stock. But its current popularity with investors may give good reason to hesitate. Apple's stock may have appreciated too much, making it expensive. The current price-earnings ratio is 32, vs. just 20 for the average computer maker. While that doesn't constitute a reason to sell, it does suggest it may be late to get in now.

Many money managers who don't already own Apple are steering clear at this point. "I can't say it's not a great company, but what do you do for an encore?" says Brent Wilsey, president of Wilsey Asset Management in San Diego. "I wish I had seen that they would have such tremendous growth in earnings," he says, "but they are not going to have anything like that going forward."

Wilsey sees competition in the iPod market increasing and earnings growth inevitably slowing. In its fiscal third quarter, one-third of Apple's revenues -- $1.1 billion -- came from the sale of 6.2 million iPods. It sold 860,000 in the same quarter the year before, for year-over-year unit sales growth of better than 600%. In the third quarter of 2004, iPod-derived revenues totaled just $249,000. Meanwhile, overall revenues this quarter reached $3.5 billion, up from $2 billion in the same quarter a year ago.

$50 TARGET. But due to more competition and tough comparisons with this year, Megan Graham-Hackett, an analyst with Standard & Poor's, predicts only 14% revenue growth in 2006 -- that's better than other computer makers but far slower than Apple's recent past. She rates the stock a hold.

Wall Street analysts tracked by Thomson Financial expect 17% revenue growth and just 14% earnings-per-share growth in 2006. Most of them recommend that investors buy Apple shares, but their median price target is $50, just 10% above the current price, according to data from Thomson. That isn't much room for upside.

Wilsey worries that if Apple misses analysts' earnings estimates -- which many hiked after its third-quarter report on Aug. 14 beat their estimates for the seventh consecutive quarter -- the stock will get slammed. "It's just so hard to follow up on the kind of growth we've seen," he says.

EXPO PROMISE. In its July 13 earnings release, Apple told investors to expect 32 cents in earnings per share and revenues of $3.5 billion for its fiscal fourth quarter. Apple fans are confident that the computer maker, which has reinvented itself multiple times in the past 20 years, can beat estimates again. They see several scenarios for how it could surprise Wall Street on the upside in the future.

Mark Stahlman, technology strategist at Caris & Co., a boutique investment bank in New York City, upgraded Apple to a buy on Aug. 15, because he has high hopes for its new lines of Macintosh computers and expects product announcements at the Sept. 20 Apple Expo in Paris to generate new excitement.

He also believes Apple will soon announce that it's developing a video iPod that would attract many new customers to the device. "We're in a period where customers are looking for premium, quality, and feature-rich products," he says, "and Apple is the ultimate premium brand."

SEXY PHONES. Paul McEntire, chairman of Skye Investment Advisors in Redwood, City, Calif., feels most encouraged by Apple's expected entrance into the mobile-phone market. For several weeks, industry watchers have been saying that Apple, in partnership with Motorola (MOT), will soon unveil a phone tied to its iTunes music service (see BW Online, 8/31/05, "Picking Up the iPhone Buzz").

McEntire says the coming music phone could signify just the start of Apple's revolutionizing the cell phone -- improving the design, adding new functionality, and making it easier to use.

"I'm happy with them doing what they're doing, but I'm hopeful that they will make a big splash in the cell-phone arena," he says. "They are so good at designing products that are user-friendly and have sex appeal." If it starts having success, he believes the potential for sales growth could attract many new investors to the stock.

"OPEN-ENDED GROWTH"? Indeed, Richard Sheiner, principal and portfolio manager of Geneva Investment Management of Chicago, says his firm may soon add Apple shares to its large-cap growth portfolio, although it doesn't currently own the shares.

Sheiner thinks the popularity of the iPod combined with Apple's retail stores are bringing more customers to Mac computers. "Apple stores are very important for getting the message out," he says. He's also excited about new cell-phone products and the potential for iTunes to turn into a "cash cow."

Given Apple's high share price, "we had our reservations," says Sheiner. But the firm now feels confident that Apple embodies much more than just the iPod. "We're looking for open-ended growth stories, and a lot of times they are expensive."

STAY AWAY, OR PLAY? Most professional portfolio managers contacted, however, expressed the same worries that Michael Cuggino, manager of the Permanent Portfolio Fund, did: "It's a great company, but given the price and the prospects going forward, I'm not sure how they can continue that growth."

For most investors, staying on the sidelines until Apple's new growth strategies take hold might be the best approach. Apple fans who don't yet own the stock may be more willing to pay up for a chance to get in early on the next innovation wave. Just keep in mind that the stock is already riding high.

By Amey Stone in New York

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