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Apple – More Downside Into 2019

Apple, Inc. (AAPL) is down 28% from its all time high of $232 per share set back in early October. The decline really accelerated following earnings release on November 1st. The company beat both top line and EPS estimates, but stock came under pressure from weak guidance by management. The stock has under-performed the broader market with concerns on future growth and exposure to China. This article will explore reasons why I expect more downside for AAPL in the near term. I have a price target of $145 per share.

My data shows that among the major market based multiples including price to earnings, price to sales, price to free cash flow, and enterprise value to EBITDA; Apple appears near "fair value" or slightly under-valued relative to historical averages. However; the stock also looks to have downside compared to the historical range of those same multiples.

Recent corrections in Apple going back ten years shows the stock has a pattern of trading well below the long term multiples average. My bear case and tactical short thesis is that given the context of the current trading environment in global financial markets, poor sentiment related to trade with China, and company specific growth concerns suggest the stock will remain under pressure.

The current weakness in Apple's stock price is the third major correction since 2013. Going back to September of 2012 when the stock crossed the split-adjusted $100 mark for the first time; APPL went on to lose about 44% in value just seven months reaching the $55 handle in April of 2013. For reference the stock split on a 7-for-1 basis in June 2014. Another correction between 2015 and 2016 saw shares decline by 32% from the highs to the low before continuing the secular uptrend reaching a high of $233.47 this past October representing a peak market cap of USD $1.1 trillion. This latest "pullback" will be marked by not only its speed, taking place in just a two-month period, but as part of the larger context of historically volatile equity markets of Q4 2018.

Apple Multiples

Looking at a longer term stock price chart of Apple referenced to its historical trailing-twelve-months price to earnings ratio, the current P/E of 14.16 is down from the peak 20.4 this September. What's curious about this chart is that the current five and ten year historical P/E average, both coincidentally at 15.5, suggest Apple's current share price is undervalued by about 7%. On the other hand Apple traded as low 9.93 in February 2016. What I'm focusing on is that in each of the previous downtrend, the P/E ratio moved below at least 12.0 each time which represented a bottom. From the current price of $168.25 per share, a P/E of 12 implies a stock price of $142.59 which is near where I would be a buyer. I see AAPL facing contracting multiples in-line with falling valuations for the broad stock market.

Price to Book value is the only metric that really stands out as still "stretched" relative to long term averages. The number on its own is largely meaningless but for context I believe the ratio has trended higher in recent years, from a low of 4x in 2016, based on the growing importance of Apple's services like Music and Apps. As revenues and earnings become more diversified away from "hardware", with services having a more material impact, I think its fair to price Apple at a higher P/B multiple. Still; no one will argue that the peak of 10.3x this past October was not overvalued given the steep decline that followed. I think the ratio can trend a lower from the current 7.45x with a share price target of $145 per share implying a P/B ratio of approximately 6.5x.

Current TTM Price to sales of 3.2 is just about at the five and ten year average of 3.3 and 3.4 each respectively. Again, the pattern here is very similar to that of price to earnings in that previous corrections in the stock moved the price to sale ratio lower each time bottoming at a low around 2.2. Given expectation of Apple's still strong revenue growth, I don't expect the P/S ratio to collapse to the historical low, but a level 15% lower around 2.75 has precedence. A top line miss in the next earnings release or weak guidance could quickly change the narrative a drive revenue estimates lower. The market likes to focus on the margins of growth, and any weakness will represent further pressure for the stock.

Summary

The above table summarizes Apple's current trading multiples in relation to 5 and 10 year averages and the lowest levels over the period. Relative to the averages, Apple's current valuation is overall fair but there is room to fall considering the historical range. I'd like to see the P/E closer to 12, P/S around 2.75, and P/B fall to 6.5 before calling a valuation bottom. Multiples contraction can extend into next year with weak earnings or revisions lower to estimates driving the stock lower.

Looking back at 2013 and 2016, the dynamic for Apple at the time was that revenue and earnings growth turned negative for a couple of quarters driving pessimism in the stock coinciding with the multiples reaching extreme levels. In contrast the theme today is more macro based including global growth concerns and Apple's exposure to China amid the ongoing trade dispute. Separately; recent headlines of a Chinese court banning the sale of older iPhone models, siding with the plaintiff Qualcomm, Inc. (QCOM), doesn't help with sentiment. And that comes back to Apple's biggest challenge at this time; which is sentiment. The stock may look cheap, but may very well get cheaper.

Takeaway

The biggest mistake investors and traders can make is assume a scenario is not possible. The purpose here is to present a path demonstrating how Apple can go lower. The possibility of Apple trading at 12x earnings is not unheard of and a very real possibility over the next few months. Looking ahead, the hope for bulls is to get some positive headlines around the US-China trade dispute into the new year and fiscal Q1 earnings in early February will like be the next major catalyst. Given the importance of Apple in the US equities market representing a 3.5% weight in the S&P 500 Index (SPY) and 10.6% in the NASDAQ 100 (QQQ), I don't see a scenario where Apple stock can recover significantly without the broad market, or vice versa. If you are bearish on equities, stay bearish on AAPL.