The Biggest Apple in the Barrel

Apple rules.

That may sound flippant, but it reflects the reality of the role that Apple Inc. (AAPL.O) plays for both the stock market and especially for technology stocks. In the fourth quarter, the company sold an astounding 37 million of its iconic iPhones – far more than analysts had expected – generating some $25 billion in revenues. Sales of its iPads – introduced to the market only about two years ago – also have exploded; in the fourth quarter, sales totaled 15.4 million units, up from 11 million in the third quarter. That translated into blockbuster earnings for the company for 2012. (For more insight into Apple’s performance, the sources of its earnings growth, and its impact on the market, please see the package of interactive graphics, below.)

That has created an almost feverish demand for the company’s stock, which is up 50.5 percent so far this year. Mutual funds that owned Apple did well during the first quarter; investors who avoided the stock were doomed to underperform, because the jump in Apple’s share price accounted for a third of the 20 percent year-to-date return in the technology sector. Apple represents 4.5% of the capitalization-weighted Standard & Poor’s 500 stock index; it has contributed 1.68 percentage points to the index’s advance this year.

Even more significantly, as this article published today by Reuters spells out, in the absence of Apple, the technology sector would be expecting to record earnings that were flat during the just-ended first quarter compared to year-earlier levels. Once you factor in Apple’s forecast results, that small decline suddenly becomes a healthy gain of 7.9 percent. Increasingly, Apple is the technology sector. The company’s impact on S&P 500 forecast is less significant, but still dramatic, transforming a 4.4 percent forecast growth in earnings per share into a 6 percent advance.

Apple’s actual impact could end up being even more sizeable. The I/B/E/S consensus forecast for Apple’s earnings calls for the company to report earnings per share of $9.94 when it announces its results on April 24, meaning that it would have seen earnings jump by more than 50 percent for nine consecutive quarters. But there’s a reasonable chance that some analysts – once again – may be underestimating Apple’s actual performance. The StarMine SmartEstimate, which places a greater weight on the most recent estimates published by those analysts who have a track record for being most accurate in their forecasting, now stands at $10.35 a share. That gives the company a Predicted Surprise of 4.1 percent, a level at which the StarMine research team sees the company as increasingly likely to report a positive earnings surprise, and thus see face further upward revisions to analysts’ price targes.

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Moreover, two analysts who have been awarded five-star ratings by StarMine for their historical accuracy have stuck their necks out with what are known as “bold estimates”: forecasts by these five-star rated analysts that are either significantly above or well below the prevailing consensus. In this case, one analyst is calling for Apple to report net income of $10.74 a share; the other is predicting the company could earn $10.98, more than 10 percent above the consensus forecast. (These analysts have been accurate in the past, and are likely to be right again in the future.) While only one analyst has cut his earnings estimate for Apple since January, 38 others have raised theirs. It seems as if the gap between the earnings that analysts believe the company can generate and what Apple actually harvests in the form of quarterly profits is widening – and investors are the beneficiaries.

That said, by the fourth quarter it seems likely that Apple’s dominance will ease slightly. Our research suggests that in the final three months of 2012, earnings for the S&P 500 without Apple will grow 17 percent; including Apple, they will increase 16.3 percent. Given Apple’s outsize earnings growth rates and the magnitude of the positive surprises, comparisons over year-earlier periods will get tougher, making it more likely that the index’s earnings growth rate will gradually become larger relative to that of Apple. (The gap could be wider in the technology sector.) It’s not as if Apple’s earnings will slip into the doldrums, however; the consensus estimate for the fourth quarter of 2012 now stands at $14.51 a share. That estimate may be revised higher as we move closer to Apple’s reporting date in January 2013.

Between now and the end of the year, however, investors will still face a conundrum. Do they own Apple, and collect not only the company’s new dividend (however small) but also profit from future upside earnings surprises? Or do they shun the risk associated with owning a company whose share price has come so far so fast that even if it executes perfectly, some longtime holders will be tempted to take some profits off the table and put downward pressure on the stock?

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As the chart above shows, Apple’s price/earnings ratio has fallen dramatically in recent years, as its earnings growth rate has accelerated and the company has delivered quarter after quarter of blockbuster earnings. Today it trades at 12.6 forward 12-month earnings, only a fraction of a percentage point above the level for the S&P 500 as a whole. Indeed, at current prices, Apple continues to trade well below the $857.50 level that the StarMine Intrinsic Value model calculates as being its fair value (based on the StarMine forward 10-year SmartGrowth rate of 13.8%). Based on this analysis investors may still have a comfortable cushion even in the wake of the stock’s remarkable recent performance.

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