Are you ready? The biggest earnings announcement of the week hits after the bell today.
I’m talking about none other than Apple’s (Nasdaq: AAPL), the world’s largest company and the market’s most widely held stock.
Analysts expect Apple to report a 56% increase in quarterly profits to $9.96 per share. And sales are expected to jump 49% to $36.7 billion, according to Bloomberg data.
Of course, expectations mean nothing when it comes to Apple.
As The Wall Street Journal puts it, “The company has a history of under-predicting and blowing out the Street.” That’s no exaggeration, either.
Take last quarter, for instance. Apple topped profit expectations by a whopping 36.5%. Meanwhile, the average company in the S&P 500 Index only beat expectations by 3.7%.
And over the last 25 quarters, Apple’s only missed earnings expectations once, according to Bespoke Investment Group.
Given its history of surprising so strongly to the upside – and the stock’s 11% pullback from its intraday high on April 10 – does that mean today represents a last-minute buying opportunity?
I wouldn’t be so quick to pull the trigger. Here’s why…
Even Apple Can’t Defy the Golden Rule
In the 17th century, Swiss mathematician, Jacob Bernoulli, proved that a variable reverts to a mean over a large sample of results. Applied to stocks, Bernoulli’s Law means that a company experiencing high earnings growth and a rapid rise in share price is destined to experience a slowdown, as the company grows ever larger.
Don’t believe it? Consider the track record of these previous titleholders of “The World’s Largest Company”…
- In March 2000, Cisco Systems (Nasdaq: CSCO) hit a market capitalization of $557 billion. Fast-forward to today and its market cap is just $106 billion.
- In early 2002, Microsoft (Nasdaq: MSFT) ruled the world with a market cap of $276 billion. Today, it stands at $270 billion. So not counting dividends, shares have essentially treaded water for a decade.
- In 2005, General Electric (NYSE: GE) earned the top spot with a market cap of $370 billion. Now its market cap is $202 billion.
- And at the end of 2006, Exxon Mobil (NYSE: XOM) earned the title of the world’s largest company with a market cap of $447 billion. Today, its market cap is down to $402 billion.
Even a recent analysis by Eric Swarts of Market Anthropology underscores the unfortunate fate of the world’s largest companies. He found the companies “certainly did not go bust… Their valuations simply matured and lost the enormous momentum drive that propelled them to unsustainable growth trajectories.”
So betting on Apple now is betting it will be an exception. In other words, the odds aren’t in our favor. Especially when you start to dig into the actual numbers.
At its current size, Apple is almost worth the same as the roughly 500 publicly traded companies in Spain, Portugal and Greece, combined. As of April 10, the company’s market cap stood at $586 billion versus $590 billion for the debt-laden European countries, according to Bloomberg.
If Apple’s share price rallies an average of 46.6% per year for the next decade – like it did over the last 10 years – its market cap would balloon to $24 trillion by 2022. That would roughly be equivalent to the size of the entire U.S. and Chinese economies in 2011, combined!
As Robert Chira, an analyst at Evercore Partners, says, “If you extrapolate far enough out into the future, to sustain that growth Apple would have to sell an iPhone to every man, woman, child, animal and rock on the planet.”
That’s not likely. So neither is it likely that Apple’s stock price is going to keep charging higher, unabated. Especially in light of the other red flag the market’s waving…
Apple: Not a Buy At Any Price
Normally, companies that are growing at a faster clip than what’s average command a premium valuation. Apple definitely qualifies.
In 2011, it increased sales and earnings by 68% and 96%, respectively.
The only problem? The stock’s not trading at a premium to the market. It’s trading at a discount.
At current prices, Apple trades for about 11.5 times forward earnings. That compares to 13.8 times for the S&P 500 Index, according to Morningstar.com.
Of course, analysts are trumpeting the fact shares are “cheap” as a justification for standing behind their “Buy” ratings. To me, though, the valuation disconnect is an obvious warning sign.
One Miss Away From the Gutter
It’d be unfair to label Apple a one-hit wonder. Even if its introduction of the iPhone stands alone as “arguably the single most important technological advance so far in the 21st century,” in the words of The New York Times.
But it’s perfectly fair to label the company a two-hit wonder. Without the iPhone and the iPad, Apple is irrelevant.
The two products now account for about 65% of revenue. And without them, Apple’s impressive sales growth of 16%, 56% and 69% in fiscal 2009, 2010 and 2011 plummets to -3%, 12% and 8%, respectively.
My point? If Apple doesn’t continue to introduce new product categories – and instantly dominate the market – its stock is destined to fail. It can’t keep growing at its current breakneck pace on the backs of the iPhone and iPad alone.
I’m sure the visionary Steve Jobs left the company locked and loaded with a few ideas before his premature death. Buying Apple now, though, is a bet that the new CEO, Tim Cook, can execute on those ideas… and that he can come up with a few more of his own.
Bottom line: Wall Street is head over heels in love with Apple. Out of 56 analysts covering the stock, only one rates it a “Sell.” But the contrarian in me views such universal enthusiasm as a warning sign.
Add in the track record of previous holders of the title of “The World’s Largest Company” and it only solidifies my conviction. An investment in Apple right now carries much more downside risk than upside reward potential.
Ahead of the tape,