A drumbeat of bad news for Apple is casting doubt on the argument that the world’s most valuable company is immune to risks related to economic turbulence.
Tepid sales in China for its new iPhone models have fuelled concerns about Apple’s ability to justify its pricey valuation and avoid a streak of four-consecutive quarters of falling revenue — which would be its worst run since 2001. That’s as the company grapples with political tensions with China and overheating devices, while KeyBanc this month became the latest firm to downgrade the stock.
Apple’s lack of growth and the high cost of its stock is creating a disconnect that’s hard to ignore, according to James Abate, chief investment officer at Centre Asset Management.
“Apple has some of the weakest growth among the megacaps, but the stock hasn’t de-rated to multiples it saw in previous periods when it wasn’t growing,” he said in an interview. Abate believes that investors should hedge against Apple’s valuation risk through put options, due to its “systemic” importance to the stock market.
Shares have dropped more than 10% since the end of July, compared with a decline of 5.4% for the Nasdaq 100 Index over that period. The slump has erased more than US$340-billion in market value, though Apple remains the biggest component of the S&P 500 Index, accounting for more than 7.1% of the index weight.
That influence in markets makes it difficult for equity investors to avoid, but other megacaps may offer more enticing growth prospects and trade at more reasonable multiples.
No growth
“You can make a compelling fundamental case for Amazon as a margin expansion story, for Microsoft and Nvidia as part of the AI craze, or for Alphabet and Meta weathering a slowdown in consumer advertising, but Apple has demonstrated no revenue growth for some time,” Abate said. “It isn’t like Cisco in 1999, about to fall off a cliff, but if we got a real dislocation in markets, the brunt would probably fall on stocks like Apple.”
The company will report its fourth-quarter results in early November, and analysts expect to see revenue down 1% from the year-ago period. Revenue for the overall S&P 500 tech sector is seen up 1.5% this quarter, according to Bloomberg Intelligence.
Against this backdrop, Apple trades at 26.5x estimated earnings, above the multiple of the Nasdaq 100 Index and its own long-term average. It also trades at a premium in terms of forward sales, while its free-cash-flow yield is below 3.7%, compared with its 10-year average of about 6.4%.
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While revenue growth at Apple is expected to return to positive territory in its 2024 fiscal year, the pace is well off levels seen in recent years, and new product categories like its Vision Pro headset aren’t expected to become meaningful drivers anytime soon.
This has already caused some to step back. KeyBanc Capital Markets recently cut its view on the stock to the equivalent of a hold rating, citing concerns about the valuation and growth potential.
Following a number of downgrades this year, the consensus rating on the stock — a proxy for the ratio of buy, hold and sell ratings — has dropped 9% off a December peak. Fewer than two-thirds of the analysts tracked by Bloomberg recommend buying, by far the lowest ratio among megacaps.
“There are always challenges, but this does seem like a trickier time, especially with the multiple being at the high end of the historical range,” said Michael Kirkbride, portfolio manager at Evercore Wealth Management. “We’re very cautious about adding to positions here, but would love to buy at a lower price.”
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Despite that, Kirkbride said Apple deserves the benefit of the doubt, given the company’s ability to navigate challenging times in the past.
“Apple remains a top brand globally, it has unparalleled supply-chain expertise, and its free cash flow means that the return of capital is historically different than you get at other companies. It’s worth sticking around for that.” — (c) 2023 Bloomberg LP
