APPLE ENTERS A DANGEROUS PHASE

By Carl Swenlin, Decision Point

Apple is a great company, and AAPL has been a great stock since early-2009. From that point to the end of 2011 it rose +300% in an orderly, relentless advance. The angle of the rising trend line was conservative and sustainable. Unfortunately, since the beginning of this year AAPL has begun a vertical ascent, which is not strictly a paraboic, but the result of which will almost certainly be the same — a price collapse.

Vertical price moves signal that a bubble mentality has taken over the market (the market in AAPL, not necessarily the entire stock market), and bubbles almost always end badly. When prices finally turn down, they usually drop as fast as they went up.

Chart

While we can be pretty sure of the outcome, we have no way to know at what price the final blowoff top will arrive. In a recent headline someone was predicting the AAPL would go to 850. Well, that is entirely possible, but who knows? At this point, one thing we know for sure is that where AAPL is concerned, rationality “has left the building.” Use extreme caution from here out. Think housing bubble — to the majority of investors the reasons it could never end seemed bullet proof at the time.

Is a price collapse the only possible outcome? Actually, no. Occasionally, parabolic stocks can enter what is called a “high-level consolidation,” which is where price begins to move in a sideways trading range for several years. This has the effect of digesting the excesses of the previous advance. For example, if this were to happen now, the consolidation might have a range of between 400 and 600, and run for five to ten years. Emphasize, this is just an example, not a prediction.

Another area of concern is AAPL’s effect on stock indexes of which it is a component — the SPX, OEX, NDX, and XLK to name a few off the top of my head. These are all capitalization-weighted indexes, and AAPL has such a large market capitalization it has a strong influence on the performance of these indexes.

The Nasdaq 100 (NDX) provides us with a great example. The QQQ reflects the performance of the cap-weighted version of the NDX. Thanks to AAPL, the QQQ has moved about 10% above the resistance line drawn across the July 2011 top.

Chart

The QQEW ETF is the equal-weighted version of the NDX. Note that it has barely moved above the resistance line, because AAPL has the same weight as the other 99 stocks in the index.

Chart

Conclusion: AAPL has entered a dangerous vertical phase. We can only guess where the final top will be before a major correction or collapse begins, but extreme caution is warranted from here on. While you may not be involved with AAPL directly, be aware that radical moves by AAPL will also have an inordinate affect on cap-weighted indexes of which it is a component.

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Comments

  1. I think you have a great point, and being a holder of AAPL options, I am greatly concerned. But what about the fundamental analysis? Didn’t the price move up so dramatically because of the incredible earnings beat and valuation last quarter? Is this price not justified even with a P/E of 15x? If the stock dropped to 500 again, would not everyone buy it right back up again?

  2. Although presumably one has to ensure a “high-level consolidation”,is distinct from a “permanently high plateau”.

  3. Yes, I think a high-level consolidation is what we will run into verses a plateau. I am hoping that we can hold on 600 next week then hopefully get close to the 625 range before earnings on the 24th

  4. Apple’s Stock May Not Be as Cheap as It Looks:
    http://www.bloomberg.com/news/2012-02-17/apple-s-stock-may-not-be-as-cheap-as-it-looks-jonathan-weil.html

    Thanks to an accounting- rule change for which it lobbied, Apple gets to book revenue from sales of bundled products such as iPhones — which include hardware, software, services and upgrade rights — more quickly than it used to. In short, one reason Apple’s earnings have been so high is accounting inflation, and the market realizes this.
    Restated Numbers
    The easiest way to see the rule change’s impact is to look back at the two sets of numbers Apple reported for fiscal 2009. Originally, the company said it had $5.7 billion of net income for the year on $36.5 billion of revenue. Then in January 2010 Apple retroactively adopted the new accounting principles and restated its previous numbers. The restatement boosted Apple’s fiscal 2009 net income 44 percent to $8.2 billion. Revenue was revised to $42.9 billion, 17 percent higher than originally reported.
    Nothing changed economically, of course. Only the accounting did. On the surface, though, Apple’s valuation looked cheaper under the new reporting regime than under the old one.
    On Dec. 31, 2009, for instance, Apple had a market capitalization of about $191 billion. Using the fiscal 2009 earnings that Apple initially reported, its price-earnings ratio that day was about 33. Using its restated numbers, the ratio would have been about 23. My guess is a similar effect is occurring today: Had it not been for the rule change, Apple’s P/E ratio would be higher, because the “E” would be lower.
    “It would appear that the market continues to consider a significant component of Apple’s revenues and gross profit to be presently unearned and not deserving of a normal market multiple,” said Charles Mulford, an accounting professor and director of the Financial Reporting and Analysis Lab at Georgia Institute of Technology in Atlanta.
    Apple was one of a handful of companies that lobbied the Financial Accounting Standards Board for the new rules in 2009. The impact for Apple seems to have been greater than for most others, probably because of the nature of its products. Dell Inc. (DELL) said the rule switch had no material impact on its results. Microsoft Corp. (MSFT) and Oracle Corp. (ORCL) said the same. Hewlett-Packard Co. (HPQ)’s earnings got a slight boost.
    The FASB rule change had two main parts. One related to so- called multiple-deliverable arrangements, while another covered software sales. When Apple sells an iPhone, for example, the hardware and software are delivered at the time of sale. Other deliverables include the rights to future software upgrades and other features.
    Economic Life
    The old accounting rules required Apple to defer large chunks of its revenue and recognize the amounts gradually over each product’s economic life. While the details are complicated, the gist under the new rules is that Apple is allowed to record more revenue upfront.
    What’s unknowable is how much different Apple’s latest results would have looked had the FASB not amended its standards. There’s no way to tell from the company’s disclosures. Plus, Apple adopted the new accounting principles right before it introduced the iPad. An Apple spokeswoman, Kristin Huguet, didn’t return phone calls seeking comment.
    Let me be clear: I’m not opining on whether Apple is overvalued or undervalued, and I’m certainly not making any predictions about its stock price. The point here is that it makes sense for Apple’s earnings multiple to have declined significantly once you consider how the company’s accounting has changed.
    The bottom line: Not all iEarnings are created equal.

  5. On the accounting change matter, and while I’ve not studied it, it would seem that FASB would want assurance (based on legal terms of sale) that there was no contingency involved in re the sales dollars.

    That is, if Apple has no legal obligation to return/refund/rebate sales dollars associated with the software and any possible upgrades, then logic dictates that it’s aceptable to book all the revenues (and their effect on EPS)at the time Apple has fully discharged its obligations … at the time of sale.

    So the real question is, did the Bloomberg journalist take his analysis – and understanding – far enough into accounting theory to support his line of thinking?

  6. Either way, what is more disturbing to me is that pretty much everyone defends the stock. Shorts are non-existent.

  7. “Shorts are non-existent.”

    If you had followed Apple this sentence of yours is laughable.

    There is one company where your statement holds true is Amazon with a P?E of 130 vs Apple P/E of 15.

  8. Apple has 13000 employees in Cupertino.
    Roughly 30% are entry level 5s managers.
    Come April 28,29 they will have roughly 220 RSU grants, and non qual options at with an avg strike price of 175? say they worked there since 2005. So they have 1800 accumulated non quals with prices dated every may of the price of apple stock.
    So 13000 employees times level 5 avg. of 30% of all employees= 3900 employees with those benefits + or -.
    Take the RSU avg for this employee level that’s 3900 employees with 220 RSUs coming available at an execute grant price of $600 = that’s $132000 per employee x 3900 at this avg. manager level= $514,800,000.
    RSU a are taxed immediately on the date available at 37.5% thus= Cupertino and surrounding areas( restaurants, contractors,auto, retail, etc. etc.) will after tax net $311,625,000. And the great state of California will get $203,1750,000. Just on the middle level apple employees. What about the Non qual options? What about director RSU grants of 10% of all 13000 employees?What about level 8 executive directors? What about the LTI Performance Unit Grants the executives at level 7 and above get?
    Add in there non qual options. DO YOU have any idea how much money CALIFORNIA is a bout to get?
    YOU LAZY REPORTERS BETTER GIVE ME VII CREDIT when you finally break this story that Apple just pulled this state out of its funk. I can share the employee benefit info…if your nice. How about bonuses paid March? What are they taxed at.. 41-43%. Taxed as though it’s income received every month. Does anyone know what the target payout was this year? I do.
    Does anyone know how much money a Director will get on average based on the mid range of the salary band at level 5 of $120,000?
    220% of target?300%? Just know the bonuses are obscene…ridiculous…occupy should head to Cupertino that’s where the money is.
    So let’s get to the point.
    California with its front page on Barron’s 2010, meredith Whitney calls is about to get lifted out of its funk by that chart above.
    And all that money…YEAH @ leverage and @ Dr. HUSSMAN it’s about to do what your permanent income hypothesis says it doesn’t.
    Ben bernankes wealth effect is about to rain on down. Into restaurants, into college funding, into retail, into state tax receipts, into housing, into charitable giving, into philanthropic ventures and probably into some strip clubs.
    This after California has made huge state cuts..
    Everyone spends way too much time on why apple stock will fall, why the bull market will end, why investors are foolish and not one second on how much good this high priced, frothy hedge fund owned stock is about to do for 33,000,000 Californians, and small businesses.
    So I like the chart above and I love what the wealth it has created will do for many Californians who could use some work..wether they be teachers, blue collar construction, or a chef whos reading this and may decide to open up a restaurant they always wanted to in Cupertino. Certainly.. Good food would be in demand for The wealthy apple, oracle, face book etc etc. employees.
    Buy stocks!

  9. Oops iPad typing mistake…directors salaries are not 120k . That is level 5 managers. Directors bands are much higher…

  10. I may actually get the % break down from my apple HR contact and calculate the entitle economic benefit assuming all RSU grants, LTI! PSU, non quals get exercised. Cause why wouldn’t u at 600?
    Calculate out the salary band target bonus payouts and whalaaa I’ll come up with a figure which will blow your mind.
    Don’t you think our state knows what’s coming?
    Remember only NON Quals need a price higher…even if apple goes back to 300 RSU, LTI, PSUs are granted at the market price and can be sold the same day every year.
    So what about all the IPOs, and other tech companies? Not just in our state but North Carolina, Boston, tennessee, Washington, etc.
    While everyone is waiting for apple to fall..it as well as other lofty stocks about to cause ZERO hedge to go full force, all in bearish propaganda. I know a bunch of people about to sell apple. Apple employees and this state will be swimming in cash.

  11. With a stock this popular, don’t you think there is a reason the p/e is where it is? Under your current theory, smart money is just too dumb to see what you see?
    The p/e is where it is and has been for some time simply because that’s where the market sees it for the foreseeable future. Please note that I am referring to p/e not just p.

  12. And why was it laughable to point out the short float? It is at 0.5%, only 10 million shares. That is indeed non-existent. What are the potential consequences? None? Good luck with that.

  13. correction 1% not 0.50, which is the ratio. In any case, that is what is laughable, not pointing it out you douche.

  14. @VII

    I just read all of your post and I find it very insightful. I notice a lot of banks have been raising their target price on Apple. So do you think it will be hard for Apple to cross 600 because a lot of employees will be selling at that price for a while?

  15. @ Anonymous

    First..I got real excited and misrepresented fed. Vs state taxes..I was in a tizzy when I started to think about how much tax receipts will be coming in based on corp. employee bonuses and stock prices high being exercised this year. But of the 37.5% state and fed as well as the 40-43% on bonuses and then as the $311,000,000 in income on JUST the 30% of the 13000 employees in Cupertino remember everything they buy on that 311,000,000 is taxed..with the exception of the lap dances..that tax comes when the wife files and takes half. But my point is that this is BIG for any corporation in any county/ state. It helps all of us in some way. A teacher gets rehired, a project gets funded.
    It’s almost like 2000 tax receipts our state was accustomed too but instead of being fiscally irresponsible…our state has made huge cuts and is much more fiscally conservative( as Cali. Liberals can get that is) than we were in 2007 and 2000. Thus the benefit should be substantial.
    I personally have not seen a study in employee exerting RSU, LTI! Non qual grants. Thus my experience from watching how stocks are affected each and every year around this time…I could not Speak too. I dont have enough info. On this too know. Sorry.
    But I can take one of my apple clients statements and break down the taxes etc. and then multiply this by her level at apple. Roughly 10% are directors and doing this…it’s huge. It’s ridiculous! How much money will flow into northern California in Q2, Q3.
    Is it permanent? NO but the state has restructured enough so that it probably wasn’t counting on the SPX and SPX corporations domicled in Cali….to benefit the state as much as its about to.
    Point is…while everyone is focusing on why the stock will drop soon….before its done it will be one of many tech companies that just pulled California out of a big black unfunded hole.

  16. VII, are those salary numbers real? And the levels? I know nothing about Apple and am really curious. Does Apple really have 9+ levels? Managers making $120k? Or am I misreading? From my experience they are crazy compared to the east coast.

    Here’s typical numbers from my companies.
    Individual Contributor (engineer with 10 years): $100k to $125k, 0-5% bonus.
    A level manager, 5 to 10 reports: add 10%, plus 5-10% bonus.
    B level manager, 10 to 25 reports: another 10%, plus 10% bonus.
    C level, same, and so on.
    B or C levels may be Directors; C levels may be VP or Dept Head.
    D or E level is usually an officer.
    New York add 25%.

    When I worked for GE (a long time ago) Jack Welch was only 7 levels up.

  17. Sorry, but this is utter rubbish.

    This is just cash accounting vs accrual accounting. In the past, under Sarbanes-Oxley rules, Apple took the conservative accounting route and deferred ALL of its iPhone revenue over 8 quarters. All of the money was in the bank, but Apple only counted 1/8th of it a quarter. Under the new FASB rules, Apple need only defer the amount of the product that might get updated over time. If Apple offers free updates of its operating system to consumers, under Sarbanes-Oxley, it has to assign a monetary value to that update, and defer that income. Previously, Apple deferred revenue on the whole iPhone, now it can defer revenue only on the actual part that gets updated, the OS. This is far more accurate and nothing fishy is taking place.

    Further, the reason why this affected Apple more than others, is because of the incredible growth of a billion dollar business. Usually, new lines of business take time to grow. The deferrals are small relative to the company’s existing lines of business, thus non-GAAP and GAAP numbers are very close to each other, and the difference closes as time passes and as the rate of growth of the new product line moderates and becomes steady. For Apple’s iPhone, the rate of growth was explosive, and the profit as a percentage of the whole business was large, thus the unusual effect upon Apple. Further, while most would expect Non-GAAP and GAAP to come together after about 2 years or 8 quarters, because of the iPhone’s sustained growth, it would take far longer, thus Non-GAAP and GAAP were not close.

    Lastly, while you may think the market is discounting the new accounting rules, then why was the market giving Apple such a high PE before the iPhone’s launch, when Apple had virtually no deferred revenue?