Hot Stocks for a Cool Market: Why Apple Is Underpriced

Apple Stocks
Apple Stocks

Summer's heating up, but apparently the stock market didn't get that memo. Still, there are plenty of places for burned investors to find respite. In this series, we highlight companies we think will warm up your portfolio's returns.

Apple (AAPL) has been on fire. It just posted the most impressive quarter in its history -- a period which saw iPhone growth continue unabated and the iPad repel all tablet challengers.

Apple's stock, however, is decidedly cool at the moment -- it's actually trailing the broader market so far this year, and is trading at historically cheap levels. Just take a look at how far its P/E ratio -- the most often-used means for valuing a stock -- has sunk below its historical average.

Source: Capital IQ, a division of Standard & Poor's. Each point corresponds to a quarterly P/E average.

Apple's trading at the same P/E ratio it saw during the financial crisis, a time when chaos reigned in the market and almost all companies traded significantly below their value.

Why Apple's So Cold

Pinpointing why a stock is undervalued is an inexact science, but several factors weigh against Apple.

  • The company is getting BIG. Apple's market cap is now 44% more than Microsoft (MSFT) and 86% more than Google (GOOG). Investors are used to Microsoft dominating operating systems and Google dominating search. Apple's still the new big-tech player on the block, and how long can its dominance of smartphones and tablets last? Consumer electronics buyers are notoriously fickle; you're only a design flub or two away from a slide into irrelevance. Plus, with Apple this big, what funds are left to buy it?

  • The iPhone 5 is delayed. Typically, Apple releases new iPhone models in late June or early July. However, we're into July and Apple still hasn't taken the wraps off its next iPhone model. With a litany of very competitive Android phones consistently adding new features and looking to one-up the iPhone, the market is uneasy with the idea that no iPhone is ready for release.

  • The "Steve Jobs Factor." Few companies are as tied to the soul of their CEO as Apple is. With Steve Jobs in the midst of another medical leave, there are fears his condition may keep him from focusing enough attention on Apple.

How Apple Will Start Heating Up

I think all of those concerns are overblown. Yes, Apple's getting big, but that largeness is validated by its success.

Apple grew earnings by an amazing 92% last quarter. That blows away competitors like Microsoft and Google. That kind of growth for a company of Apple's size is simply unparalleled. More to the point, that growth looks to continue. Analysts expect Apple to grow by another 16% during 2012. That might not look impressive until you realize analysts always underestimate Apple's earnings. In the past four quarters, Apple has smoked earnings estimates by an average of 17%.

As for the competition, many Apple detractors like to point out Sony (SNE) as a comparable, but Apple continues building a strong software advantage. Users become wrapped up across its iTunes media ecosystem and download large numbers of apps that make them reluctant to move away from Apple once they've adopted its products.

Yes, Apple's iPhone is delayed, but now that the iPhone is on Verizon (VZ), its sales are brisk and it's picking up market share among new-phone buyers once again.


Besides, the iPhone is truly a global success story. Last quarter, Apple announced that iPhone sales had increased 250% year-over-year in China. In total, the company rang up $5 billion in sales in China alone. The next iPhone might be delayed, but with an update to iOS coming in September -- with the likely scenario that the iPhone 5 accompanies it -- Apple's smartphone machine looks to be chugging along at full speed.

As for a future without Jobs, Apple's got that covered, too. While there's no way to deny Jobs is the heart and soul of the company, he's also trained up a core group of potential successors. Jonathan Ive has been the design inspiration behind every blockbuster Apple product since the days of the iMac. Phil Schiller has been the company's marketing guru across Apple's run to the top, and Tim Cook handles the logistical end of Apple's sprawling supply chain. None of them on their own can replace Jobs, but with this team, the company is in very capable hands.

The Bottom Line

Like any other stock, Apple still faces a fair amount of risk. Currently, the company collects a majority of mobile phone profits with only a thin sliver of market share. If Apple can't keep innovating to maintain a "premium" perception, these outsized phone profits could begin to be pressured and its stock price wouldn't be far behind.

However, in terms of buying a company with fantastic growth opportunities trading at a cheap price, it's hard to find a company better-positioned than Apple. Bite into this deal while it lasts.

Motley Fool analyst Eric Bleeker owns shares of no companies listed above. The Motley Fool owns shares of Google, Microsoft, and Apple.

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