Apple: How Long a Rally?

The rally that propelled Apple's shares to a record has sparked debate over how much further the stock could rise, with most analysts expecting the gains to continue.

Apple's shares have come a long way in a short time. On Oct. 21, Apple (AAPL) stock closed at 204.92, besting the previous peak, set in December 2007. The next day it closed even higher, at 205.20. Almost exactly a year earlier, against the backdrop of a financial meltdown that torpedoed the wider market, Apple stock was trading at 91.49. An investor who purchased Apple then would have more than doubled his investment.

Wall Street analysts who track Apple say there's more room to run. After Apple's eye-popping Oct. 19 earnings report, most analysts fell over themselves to boost target prices, arguing in lengthy research notes that Apple's growth potential makes it worth anywhere from 225 to 280 per share. CNBC's Jim Cramer has even argued Apple could go to 300.

A Familiar Refrain Of 41 analysts who track Apple, 35 rate the stock a "buy," "strong buy," or some equivalent, while four rate it a "hold." Only two rate Apple a "sell," arguing the company is overvalued.

While price targets may differ, many of the Apple bulls sing a familiar refrain. Sales of the iPhone will continue to increase as Apple introduces the device in more markets globally, while the Macintosh computer will keep gnawing away at Microsoft's (MSFT) command of the PC market. The expected introduction of a tablet will give the stock added lift, the argument runs.

Andrew Hargreaves of Pacific Crest Securities in Portland, Ore., expects Apple to trade at 260 in the next 12 months. He reached this price by estimating Apple's fiscal 2010 earnings before interest and taxes (EBIT) at $15.1 billion, multiplying that by 13, then adding Apple's net cash balance of $34 billion. Hargreaves says his estimate is conservative, given that Apple's stock has traded at levels with higher multiples. "I don't think I'm being overly aggressive," Hargreaves says. "I'm using a number at the low end of the historical range."

Factoring in Steve Jobs Brian Marshall of Broadpoint Amtech boosted his Apple target to 235 on Oct. 20 based on 20 times the $11.75 he expects Apple will report in pro-forma per-share earnings in calendar 2010. Samuel Wilson of JMP Securities arrived at a 220 target by estimating that Apple will earn $7.23 in calendar 2010 and then multiplying that figure by 30 before rounding it up a few dollars.

Even the biggest bulls concede Apple faces risks. Apple could fumble the launch of the tablet, expected next year. It has been a long time since an Apple product failed. The last example was the PowerMac G4 Cube, retired in 2001 after only 12 months on the market. One could argue the company is unlikely to keep producing one hit after another for so long, and that it's due to stumble soon.

Another question centers on the tenure of CEO Steve Jobs. A pancreatic cancer survivor who had a liver transplant earlier this year, Jobs may leave for health-related reasons before long, some analysts have speculated. When that happens, Apple's stock is likely to take a hit—although the impact is likely to be blunted amid confidence in management's ability to run the company in Jobs's absence. Witness Apple's performance under Chief Operating Officer Tim Cook during the nine months Jobs was on medical leave. The consensus among analysts contacted by BusinessWeek is that the stock will drop between 5% and 10% on word of a Jobs departure, regardless of reason. This is a much smaller hit than prior expectations that suggested the stock would automatically drop by as much as 30%. "The market has digested his mortality," Hargreaves says.

Price Competition Is Coming A slim minority of analysts argues that Apple's stock is overvalued. Per Lindberg of MF Global (MF) in London just raised his price target on Apple by 4—to only 90 a share. And he's rated it a "sell" since early this year. Other analysts, he argues, are treating the stock in the same way they did Internet stocks in 1999 and 2000. "This will end in tears," he says. He calls the notion that Apple is worth another $100 billion "quite hilarious."

Price competition is coming to the iPhone, he argues. As proven by Motorola's (MOT) RAZR and numerous Nokia (NOK) handsets before that, popular devices are quickly copied and subjected to stiff price competition. "You cannot, should not, and must not extrapolate what will happen in the future based on what is happening today," he says.

Phones running Google's (GOOG) Android software could in time give Apple a run for the iPhone money and force it to cut prices to keep unit sales growing. In the coming 12 to 24 months, "the iPhone will not be seen as unique," he says.

"In a Sweet Spot" Lindberg also points to falling per-unit sales of Macs. Even as overall sales of Macs surged, the average price fell by almost $83 in the last year, threatening Apple's overall operating margins. By 2015, Apple will be reporting revenues in the $65 billion to $70 billion range, but with operating margins in the range of 14% to 15%, down from 22% last quarter, Lindberg says. "Apple is right now in a sweet spot," he says. "And the sweet spot will never ever persist for long."

Absent from Lindberg's analysis is the potential sales of the tablet. Gene Munster of Piper Jaffray (PJC) has high expectations for the tablet. He expects Apple stock to rise to 277, due in part to the success of the tablet and other new products.

Apple may soon grow its revenue on paper in a big way, thanks to a change in accounting rules. Until recently, Apple was required to book iPhone sales over two years. New accounting standards will let it book most of the sale of an iPhone right away, though Apple hasn't said exactly how it will handle the change or when it will take effect. When it does, it will cause revenues to look bigger year-over-year than they otherwise would. Assuming Apple implements the change right away, Munster expects sales in 2010 to be north of $50 billion, vs. $36 billion in 2009.

Apple Rarely Makes Big Deals As a company gets that big, it becomes mathematically more difficult to sustain growth rates. Markets become saturated, new revenue streams that are big enough to matter are harder to find. It's at times like this that very large companies try to increase sales by making large acquisitions, often with unhappy results. Case in point: Microsoft, whose Windows and Office markets are mature, and so it tried to buy search portal Yahoo (YHOO) last year to boost its fledgling search business.

Given its enormous cash position, Apple could certainly make some deals, but historically it buys only very small companies that have smart employees and interesting technologies in development. The kind of big acquisitions that would make a difference to a $50 billion company are not in its DNA.

One way or the other, Apple is approaching a moment of maturity, Munster says. That makes the opportunity to invest all the more urgent, because it will not last. By the time the stock climbs to 250 or 270 or 280, the moment will have passed, and Apple's price will level off more or less permanently, he says. "Covering Apple is very simple," Munster says. "You try to predict their innovation and determine the stock's value based on that. I think innovation is still in high gear at Apple. Once the innovation slows, it's over."

But guessing when that moment will be is either a $250 billion question, or an $80 billion question, depending on your point of view.

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