Apple Is Rotten (Motley Fool)
Apple fans don't want to hear it. Analysts don't want to say it. But here it is: Apple's ready for a mighty big fall. The Borg-like fidelity of Mac zealots, coupled with misplaced enthusiasm for the firm's nifty gadgets and a giant dose of media hype, has conspired to push the stock far beyond a rational valuation.
By Seth Jayson (TMF Bent)
October 7, 2004
This week we're dueling over the prospects of one of our most popular stocks here at Fool.com: Apple Computer. Loved by many, hated by just as many, Apple separates Fool from Fool frequently in our discussion boards. We take the battle to the front page today with Fool contributor and Mac aficionado Tim Beyers defending the iEmpire while Fool Seth Jayson argues that Apple is rotten to the core. After you've read both sides, vote on which one has won your heart.
Ladies and gentlemen, the Apple (Nasdaq: AAPL) is rotten. OK, let's qualify that. After all, this is to be a discussion -- for the most part -- about Apple the company, not Apple technology. Apple's stock is overripe. Stinking. Mealy, full of worms, and wholly unsuitable for public consumption. Why? Shortsighted enthusiasm.
No doubt about it, Apple the brand is hot. Over the past couple of years, the stock has outperformed the S&P 500 by a huge margin. There's a one-word reason: iPod. The world's best-known digital-music doodad has juiced Apple's sales over the past several quarters and made the company the latest shoeshine-boy stock. What's a shoeshine-boy stock? Something like Krispy Kreme (NYSE: KKD) before it found out that reality bites. It's the popular company, the one that gets free press coverage with every new retail outlet, the stock everyone's telling you to buy. And as Lynch and others have pointed out, when the wingtip-buffing ragamuffins recommend an equity, that's a pretty sure sign that the hot streak will be coming to an end.
But the shoeshine-boy syndrome isn't the only symptom of Apple's upcoming malaise. There are others, clearly visible in the financials. Why no one seems to notice the obvious is another story, and, conveniently enough, that's the one we'll explore first.
Think different, like me!
"Think different?" I've always found this key slogan in Apple's marketing to be troubling, and not just because it shows that CEO Steve Jobs needs to brush up on his fifth-grade grammar. (Hey Stev-o, buy yourself an adverb!) It's creepy and ironic because Mac fans -- especially the ones who write me -- are about as freethinking as the lovely ladies of Stepford. They're like a pack of Moonies telling a congregation of Snakehandlers, "You're brainwashed. Join us to free your mind."
Americans have always preferred their rebellion in commercialized and socially acceptable packages -- witness GM's Hummer H2, Harley Davidson motorcycles, or the Mullet -- but wake up, people! Leaving a $300 billion monopoly to support a $15 billion one does not constitute intellectual daring.
In fact, it simply means you've got less consumer freedom, not more. Think I'm making this up? Ha! Count the PC vs. Mac software packages at your neighborhood Best Buy. Try using your iPod with competing software. Try using any non-Apple MP3 player with iTunes. This is more than a question of tech theology: Mac's legendary insularity has always been a huge anchor on growth.
Apple's iTunes and iPod are the biggest things in digital music today, and Jobs and Co. are determined to screw it up. Why? They think different, all right. By refusing to play nicely with outfits such as RealNetworks (Nasdaq: RNWK), Roxio (Nasdaq: ROXI), and Loudeye (Nasdaq: LOUD), Apple's not only passing up lucrative licensing opportunities but also missing the chance to rocket to the front of the digital music world forever.
Taking measured steps toward dominating a market is how Microsoft (Nasdaq: MSFT) came to be 20 times bigger than Apple. As things stand, Apple's congenital narrow-mindedness makes it easy pickings for the dozens of dit-music firms out there who want to take a bite out of Cupertino. Just because none of them have come up with anything as nifty as the iPod doesn't mean they won't. Low-margin iTunes is already under threat.
But surely Apple's management realizes this fatal error, right? Don't count on it.
Hey, Emperor! Nice duds!
The end result of the overdone enthusiasm for Apple is a major lack of accountability. I've worked with Macs for well more than a decade, and though they've gotten more stylish, they haven't necessarily gotten any better, especially compared with the competition.
Consider the photo and design audience. For years Apple has been milking its reputation as the computer of choice for this constituency. There was a time when Macs had a lead that looked insurmountable. That's no longer the case.
Every year I get to play with brand new Mac gear -- direct from Apple -- as the "tech guy" at a well-known photojournalism workshop. This year, as usual, I wasted entire days trying to coax the new Mac OS to make nice with a variety of printers. Plug and play? Try plug and pray. Color fidelity, WYSWYG? Not with top-of-the-line Power Macs and cinema displays, I guess. This year, incredibly, I ended up relying on a no-name Windows laptop purchased at Wal-Mart's Sam's Club to do the heavy lifting.
I'm not surprised, because I've seen this for years. But here's the odd thing: Even though the diehard Mac fans (everyone there) were cursing the quality of the machines and the OS, they remain Mac fans. They've made a lifestyle choice, and they're sticking with it. But their sheepish acceptance of the frustrating state of affairs is another drag on Mac growth. There's no need to improve when all you hear is how great you already are.
Stockholders should realize that when you're fighting for turf on the open market, style goes only so far. To judge by the public's lukewarm response to Mac computers over the past few years, Apple's not so efficient with the proselytizing. For 2002 and 2003, total Macintosh unit sales have been either flat or negative. So far this year, they're doing better, up 10%. Sound good? Dell's (Nasdaq: DELL) unit growth is 50% better, at 15%. And industry observers have recently started to wonder whether the late launch of the new iMac and limited availability of the new PowerMacs will rein in Apple's slimmer scale-up. Outside the iPod, Mac is definitely not a quick grower, so what's up with the stock price?
Two-bit Apple
Apple is one of those companies where investors are enthusiasts, and vice-versa. Sometimes, that's OK. But in this case, the result is a self-deluding, self-amplifying feedback loop. Earlier this year, there was reason to cheer the iPod's contribution to the top line. But these days, it's nearly impossible to hear through noisy enthusiasm.
The cacophonous refrain these days is the claim -- so far unsubstantiated -- that the iPod will increase demand for the company's computers. Over the past few days, the Macintosh media have repeated this contention, pointing to a single analyst's pie-in-the-sky wish for an increase in Macintosh market share. Here's what was actually written: A .5% increase in market share is "not out of the question."
Not out of the question?
Listen, a visit to my back yard from people-probing Martians is also not out of the question, but that doesn't mean you should bet your investing dollars on the likelihood. How about looking at the numbers instead? Yes, let's.
To start with the obvious, Apple's price to earnings ratio (P/E), we find a 73. Yikes! The forward P/E, based on estimates, clocks in at 43. Though it is a mistake to judge a company only by its P/E ratio, the fact that Apple's is more than twice its competitors' demands some explaining.
Hey, Apple is growing, right? So, when we account for Apple's likely rate of expansion, is the stock's price more solid ground? Hardly. When you compare the P/E to expected growth, through the PEG ratio, Apple's stock looks even crazier. Apple's PEG is an insane 3.36.
Yes, the PEG is a bit old-school, but it's still a good rule of thumb. When paying up for growth, you should start getting skeptical when the P/E exceeds the rate of growth. When they're in balance, the PEG sits around 1. You could argue that Apple's explosive earnings increase over the past year has put this metric out of whack, but even if you don't believe in absolutes, taking a look at Apple's peers provides a good dose of reality. Dell's PEG is 1.37. Hewlett-Packard's, 1.45. Even Google's 2.38 is an order of magnitude lower.
OK, we're still talking about valuation shorthand here. Certainly there must be some other reason that people are paying such a premium for Apple. Could it be superior margins? Nope, Apple's operating margins of 3% are pathetic by industry standards. Those are the kind of margins you see in cut-rate retail businesses -- 2% lower than Wal-Mart's! What that means is that Apple is going to have a tough time continuing to club earnings out of the park, even if it can scare up big sales gains. To see what a profitable tech firm should be achieving, look at Dell's 8.5% operating margins, or Microsoft's 24%.
C'mon, there must be something! How about major products in development? Nothing so far. In fact, one of the few analysts brave enough to put a "hold" on Apple recently was practically begging the firm to come up with anything new. A flash-RAM iPod, a set-top box, a media PC, anything. When the analysts start pleading for a reason to stay bullish on the Street's favorite pet rock, it's time for savvy shareholders to look for the exits.
The final word
Friends -- and by friends, I mean those of you out there furiously typing angry defenses of Apple -- open your eyes. Enthusiasm for a computer, pocket stereo, or cleverly marketed lifestyle choice is no reason for an investment. Apple's done well over the past two years, but the stock is now priced beyond perfection. For your $40 a stub, you should be getting an unstoppable business with huge growth potential. Instead, you're getting a slowing, sub-par nerd-niche operator with a shiny surface. To add insult to injury, 47% of the stockholders earnings so far this year are wiped when you consider the impact of stock options. Where's the payback for shareholders?
They wax and polish the mealy apples at the supermarket in order to fool you into buying them. Don't fall for the same trick when you're buying stocks.
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At the time of publication, Seth Jayson had no positions in companies mentioned. View his stock holdings and Fool profile here. Fool rules are here.
