Rising Star Buy: Another Byte of Apple

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This article is part of ourRising Star Portfolios series.

As we all know, Apple (NAS: AAPL) knocked it out of the park when it reported earnings last week. Again. It's almost getting boring at this point.

Earnings of $7.79 per share were ahead of expectations of $5.85, as was revenue: $28.6 billion vs. $25 billion. iPhone unit sales topped 20 million, more than 10% higher than what analysts had predicted and overtakingNokia (NYS: NOK) in smartphone volume in the process. And iPad supplies were catching up to demand even while Apple sold more than 9 million of the things.

Despite earnings growth of 125% year over year and revenue growth of 82%, the share price has risen by only 5.7% since it announced earnings. And that means the priced-in expectations for growth have barely budged since I purchased a share for my Rising Star portfolio a bit more than a month ago.

Pessimistic views
One reason for the relatively lackluster performance in the share price might be the sheer size of the company. At around $400 per share, it is rivaling the largest company in the S&P 500, Exxon Mobil, in market capitalization. We just haven't been dealing with companies this large for very long, so buyers might be unwilling to bid up the price too far. Yet I believe that in the long run, price follows performance, and Apple's incredible performance will lead to a higher price.

Another reason might be continued concerns over the CEO succession at Apple. With Steve Jobs still on medical leave, shareholders are understandably anxious about who will succeed him. I've written before that Jobs has built a strong team and that members of the board of directors have been taking some action about the succession recently. This is not a long-term concern for me.

A third reason might be uncertainty about where Apple's "next big thing" will come from. A new iPhone later this year probably generates a response more along the lines of "been there, done that" than "holy cow!" And dominance of the cloud is far from sure, with Google, Amazon.com, and Microsoft all vying for dominance beside Apple.

Still, Apple has a knack of introducing products that define their space, as they have with music players, smartphones, and, most recently, tablets, pushing all others aside. Research In Motion's (NAS: RIMM) recent decision to lay off a couple of thousand employees seems to be the latest consequence of this dominance. What will be next? I don't know, but given Apple's history, I'd expect it to be well done and well executed.

Optimistic move
At last night's closing price, expectations for free cash flow growth are 11.5% per year for the next five years, 5.8% for the following five years, and then 2.5% from then on, using my usual 15% hurdle rate to discount. This is essentially the same level of expectations as there was a month ago when I first bought. With its most recent results, Apple has proved yet again that it is capable of doing much more, so I view this as a messed-up expectation.

Tomorrow, I'll purchase a second share for the Messed-Up Expectation portfolio, representing a second 2% allocation of funds to Apple.

After you add Apple to My Watchlist, come and discuss the investment on my Messed-Up Expectations discussion board, or follow me on Twitter.

This article is part of ourRising Star Portfoliosseries, where we give some of our most promising stock analysts cold, hard cash to manage on the Fool's behalf. We'd like you to track our performance and benefit from these real-money, real-time free stock picks.See all of our Rising Star analysts(and their portfolios).

At the time this article was published Fool analystJim Muellerowns shares of Apple, Amazon.com, and Exxon and has an option position on Microsoft. He's an analyst for theMotley Fool Stock Advisornewsletter service.The Motley Fool owns shares of Apple, Google, and Microsoft.Motley Fool newsletter serviceshave recommended buying shares of Apple, Microsoft, Amazon, and Google, and creating a bull call spread position in Microsoft and Apple, as well as a diagonal call position in Microsoft. Try any of our Foolish newsletter servicesfree for 30 days. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool'sdisclosure policyis never messed up.

Copyright © 1995 - 2011 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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