Why I'm Thinking of Adding to Apple at These Prices

Each week, I report the results of the Big Idea Portfolio, a collection of five tech stocks that I believe will crush the market over a three-year period. I've done it before; my last tussle with Mr. Market ended with me beating the index's average return by 13.35%.

Real money was on the line then as it is now, which means any one of the five stocks you see below could cause me a lot of public embarrassment. None has caused me more than Apple recently. The stock fell more than 12% after reporting fiscal first-quarter estimates that failed to impress.

CFO Peter Oppenheimer also suggested that the Mac maker's lightweight Q2 estimates were likely accurate, a departure from Apple's historical preference for issuing comically lowball financial guidance. Bearish investors cited the shift as proof Apple's best days are behind it. I'm not so sure about that.


Yet I was also wrong to predict an earnings blowout. High demand for the iPad Mini didn't offset lower prices neatly as much as I'd hoped. Meanwhile, Apple sold fewer iPhones than investors predicted (47.8 million rather than at least 50 million handsets) while Mac sales fell 22% year over year. All of it combined to push revenue slightly below Wall Street's target for the second consecutive quarter.

Are you among the horde selling on the report? Are you buying? Holding tight? I'm seriously thinking about adding to my own real-money position. Here are three reasons why:

  1. We've yet to see an iTV, but we know one is coming. The late Steve Jobs told biographer Walter Isaacson that he had "cracked" the code for creating a seamless Internet TV experience, a secret he undoubtedly shared with the current team. Also, CEO Tim Cook has said television is "an area of intense interest." Skeptics who suggest Apple is done innovating -- and judging by comments we've seen here since the earnings report, there are plenty -- aren't paying close enough attention.
  2. History shows that every market has a leader and a (very) profitable substitute. Even if you believe that Android will continue to be the world's most-used smart device operating system, history shows that there's always a Pepsi to challenge Coke. Apple can be either and still collect a handsome profit for the foreseeable future.
  3. The market values Apple for stagnant growth. Following the sell-off, I performed a reverse discounted cash flow (DCF) analysis that suggests the market expects just 2% growth from Apple at current prices. You read that right: 2%, forever. The math assumes a base of $27 billion in free cash flow -- a natural midpoint between recent highs and lows -- a 9% discount rate, 939.1 million shares outstanding, and just $39.82 billion in cash and investments (the most liquid of its cash assets). I've also factored in $3.9 billion in operating lease commitments as a debt equivalent and $1.9 billion in stock options expense.

Add it all up, and I'd say the odds overwhelmingly favor Apple's ability to outperform over the next five years.

What's the Big Idea this week?
With so much attention focused on Apple, it's easy to forget that Google also reported strong results as revenue and aggregate paid clicks surged. Unfortunately, the win wasn't enough for the Big Idea Portfolio to keep pace with the comparable S&P 500 SPDR, which reclaimed 157 basis points after factoring in dividends and returns of capital.

Apple's freefall also punished the Nasdaq, which fell 0.14% as the Dow Jones Industrial Average advanced 1.29% and the small cap Russell 2000 improved 0.83%. The benchmark S&P 500 improved 0.59%  and briefly passed 1,500 for the first time since 2007, according to Bloomberg BusinessWeek and data supplied by The Wall Street Journal. Here's a closer look at where I stood through Thursday's close:

Company

Starting Price*

Recent Price

Total Return

Apple

$418.68**

$450.50

7.6%

Google

$650.09

$753.83

15.9%

Rackspace Hosting

$41.65

$79.24

90.3%

Riverbed Technology

$25.95

$19.52

(24.8%)

salesforce.com

$100.93

$172.29

70.7%

AVERAGE RETURN

--

--

31.94%

S&P 500 SPDR

$124.94**

$149.41

19.59%

DIFFERENCE

--

--

12.35%

Source: Yahoo! Finance.
* Tracking began at market close on Jan. 6, 2012.
** Adjusted for dividends and other returns of capital.

Notable newsmakers
Earnings week brought plenty of news, much of it mixed:

  • On Tuesday, Google reported a 12.1% increase in non-GAAP profit on a 36% jump in revenue. Earnings, in particular, came in ahead of views at $10.65 a share. The stock is up nearly 7% on the beat. Other revenue, which included Google Play store sales, more than doubled year over year to $829 million.
  • On Wednesday, Netflix overshadowed Apple by reporting a surprise fourth-quarter profit on better-than-expected revenue. Management also told investors to expect as much as $0.23 of Q1 profit on at least $1 billion in revenue, which would be a first for the streaming sensation. Netflix shares are up about 70% since Wednesday's close on what looks like the mother of all short squeezes.
  • On Thursday, Microsoft said it beat analyst estimates by a penny in fiscal Q2. Windows 8 sales proved to the catalyst, as revenue from the company's operating systems division increased 24% year over year.
  • And finally, Nokia said it would halt payments on a juicy dividend that was yielding as much as 5.5%. The stock fell more than 10% on the news.

What caught your eye in the tech world this week? Would you buy any of these stocks? Do you believe in the Netflix rally? Please weigh in using the comments box below. And remember: if you're Interested in ongoing guidance, we've published a detailed research report that covers not only Netflix's opportunities but also the hidden risks it faces. Click here to get your copy now, and we'll include a full year of regular updates as news breaks.

The article Why I'm Thinking of Adding to Apple at These Prices originally appeared on Fool.com.

Fool contributor Tim Beyers is a member of the  Motley Fool Rule Breakers stock-picking team and the Motley Fool Supernova Odyssey I mission. He owned shares of Apple, Google, Netflix, Rackspace Hosting, Riverbed Technology, and salesforce.com at the time of publication. He also had a long-term call options position in Netflix. Check out Tim's Web home and portfolio holdings, or connect with him on Google+Tumblr, or Twitter, where he goes by @milehighfool. You can also get his insights delivered directly to your RSS reader.The Motley Fool recommends Apple, Google, and Netflix and owns shares of Apple, Google, Microsoft, and Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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