By Parke Shall with Scott Tzu
There have been several significant events that have occurred since the last time we wrote about Apple (NASDAQ:AAPL), each one of which we believe helps confirm our bearish thesis on the company. We wanted to take a moment and write about these developments today to supplement our September article on why we think Apple is likely due for a pullback in the short-term.
First, we want to remind our readers that over the course of the long term, like over the next 5 years to couple of decades, we are bullish on Apple. The company is fundamentally sound and will likely continue to grow consistently. However, we began to construct a thesis as to why we believe the stock is starting to border on overvalued back in September. Since then, the company has put out earnings that beat Wall Street estimates and subsequently its stock price continued to rise.
Today we wanted to take a minute to briefly update our short term bearish case on the company and introduce a few new reasons that confirm our belief that the company is overvalued at current levels. Here’s what has happened since our last article,
– Apple reported earnings
– Broadcom reportedly made a $103 billion offer for QUALCOMM
– We finally got to use an iPhone X alongside an iPhone 8 and are not impressed
– The overall market continues to move higher and Apple stock has appreciated more than 10% more
Great Earnings, But a Couple Points of Note
There was plenty to be excited about on the earnings front. After all, Apple is pretty much expected now to beat earnings each quarter. Despite these expectations that we believe the market already carries, Apple did post a impressive corner. It beat both revenue and EPS estimates, it’s saw a return to revenue growth in China, product sales beat all expectations across the board for iPhone, iPad and Mac and the company is now sitting on $269 billion in cash. All told, it seemed difficult for anybody in the financial media to point out anything other than these “blowout“ numbers when reporting about the company’s quarter. With that said, there are a couple items that we are keeping a cautious eye on heading into the holiday quarter.
1. First, Apple has come out and guided for the holiday to be its “biggest quarter ever”. At face value, this appears like its great news, but we must also be cognizant of the fact that Apple is now sitting very high expectations for the upcoming quarter. The higher the expectations are set, the more positive sentiment is going to be priced into the company prior to the next earnings report. Apple will have to deliver in a significantly profound way in order to continue rallying as strongly as it has been after its holiday quarter.
2. Second, there still seems to be some unsurety as to iPhone X supply, as CEO Tim Cook fielded questions on the conference call with some relatively vague answers regarding when supply would be able to meet demand for iPhone X. With regard to supply and demand, Cook stated,
The truth is we don’t know. We’ve put our best estimate into the guidance, and you can see from the guidance that we are very bullish. And so, and we feel really great about the product lineup. We just sold the first units minutes ago. And so we’ll see how things go. Until you get all of them out there where customers have the ability to demo and support, I think any kind of mix discussion is very much estimating. And so we put our best estimates in, but grantedly, we’ve never done this before. So there’s no comparison here, with either the three iPhones nor the staggered launch. So we’re going to learn something.
Additionally, Cook didn’t get into any type of detailed iPhone product mix answers, but rather said that “the 8 Plus had the fastest start of any plus model”. The day after the earnings report, the iPhone X officially hit stores.
Broadcom Offer Marking a Top in Tech?
The recently released proposed takeover by Broadcom (NASDAQ:AVGO) to try and acquire QUALCOMM (QCOM) just days ago, we think, helps reiterate our case that the NASDAQ may be nearing a top. We have noted on more than one occasion that we believe the stock market is dangerously overpriced and that eventually the overall broader market will pull back, bringing Apple stock with it.
Apple is very much a beta stock that moves with the overall market, as we wrote about in our September article addressing some of our concerns as to why we think Apple may pull back. In that article, we stated that we thought the market was significantly over valued and that any further moves higher should be used by investors to scale back long positions. In the two months succeeding that article, both the market and Apple stock have moved higher, defying our thesis and also making the stock that much more expensive.
This was all topped off by what is being called the largest possible technology takeover offer in history with Broadcom making an unsolicited $103 billion offer for QUALCOMM. The fact that the largest possible merger in technology could be taking place helps to support our case that all major industries, but especially technology, could be nearing a top. These are not the types of deals that you see when an industry is in recession or cooling off, these are the types of deals you see during stages of euphoria.
The 8 Overshadows the X: So What’s Next in the Innovation Pipeline?
In addition to the technology sector possibly nearing a top, we want to reiterate our previously noted concerns about Apple’s lack of future innovation. We wrote in our September article that we were concerned about Apple’s innovation runway going forward and that the company may have completely blown out all of its good news and future hype with the release of the iPhone X. While the lack of an innovation runway going forward was our initial concern, that concern has now mutated into concern about how well the iPhone X is going to be received in and of itself.
We had the opportunity to use an iPhone X for the first time just this past weekend and we can’t say that we are especially impressed. Keeping in mind that this comes from a group of individuals who have been long time bulls on Apple and fans of the company‘s products, the iPhone X doesn’t seem to bring much new to the table. We compared it to the iPhone 8 Plus, which we actually found to be the nicer phone. The smaller iPhone X and the corresponding rectangular ribbon at the top of the phone just doesn’t seem like it fits the innovation and quality standards that Apple has been known for. In addition, because of the wireless charging capabilities, Apple has sacrificed weight. Both phones are much heavier and the new casing causes them to slide off of almost any fabric surface very easily.
(Source: The Verge)
The design is already being mocked by Samsung, in its latest commercial. We find this telling, as design is what Apple is supposed to be known for.
For a company that is so focused on aesthetics and design, we didn’t find that the larger screen stood out much at all. As a matter fact, it drew attention to the rectangular black bar at the top of the screen that looks misplaced and unbecoming of Apple design standards.
While the phone functioned perfectly and we didn’t have any issues with Face ID, the overall aesthetic and design when compared to the iPhone 8, we believe, makes the iPhone X an inferior phone for the price. Given that much of the company’s success heading into the holidays is going to be dependent on this phone being a blockbuster and Apple being able to meet demand (which they sounded slightly unsure of on the conference call), we’re not sure that we can throw all of our confidence behind the company‘s latest “marquee” offering. Put simply, over the last decade or so, we have expected more from Apple when it comes to a flagship product like it is trying to sell us, for its exorbitant price, in the iPhone X. While the functionality we’re sure is fine, we don’t think the design is going to bring anything new to the table that is going to make this phone stand out, nor do we believe that the X is going to significantly outperform the 8 when it comes to sales. If you recall, sales of the iPhone 8 have been reported to be hit or miss from the get go, and many analysts have tried to direct investors’ attention to upcoming sales of the iPhone X. Whether or not the product sells like a blockbuster is one thing, but we don’t feel from using it that the product is a “must have” above the iPhone 8 when we compare the two. Does Apple have any big shots left to fire in its phone innovation pipeline?
Apple Stock Will Probably Pull Back, Offering a Better Spot for Entry
And so where does this put us? It puts us in a position where the overall markets have moved even higher since our article in September. Apple stock has moved up more than 10% since we wrote that article, which you could argue makes us incorrect about our September assertions, but also that you could argue has made the stock that much more expensive.
The company had a blowout earnings report and has set the bar very high for holiday sales this year. Much of the holiday momentum is going to be expected to come from the iPhone X, which is a product that we just don’t feel has enough uniqueness and style to differentiate it from the iPhone 8, let alone to make it a $1000+ purchase at a repetitive clip over the holiday season. Apple’s forward PE remains well above its historical average, now trading at about 16X forward guidance when it has traditionally traded at about 12X or 13X.
In addition, we feel that the overall macroeconomic environment is setting up for bubbles in things like consumer credit and corporate debt to catalyze a eventual pull back in equity markets.
Given all of these factors, we believe the market will present potential Apple investors with a better entry spot than $174 over the coming months and possibly into Q1 2018.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.