Can Apple Mend Its Broken Leg?

This article about Apple's broken leg was written by Nathan Young.

In 1978, the world took no notice of a small upstart company in California that would eventually redefine the way people connect.

From its birth, through its iconic George Orwell 1984 advertisement, and into the 2000’s, Apple’s focus was on personal computers, not mega computers for universities, corporations, or the government.

In 2001, the company revolutionized music with the introduction of the iPod, propelling Apple to new financial heights and undisputed leader of the technology boom. From there, Apple constantly cranked out new products that became categories in their own-right and the gold standard that competitors had to live up to. In 2007, Apple’s first iPhone solidified the company’s dominance, and changed mobile phones as we know it.

Apple’s stock price surged 995% between September 2006 and September 2016, thanks to Apple’s work on the MacBook Pro, iPad, and recently the Apple Watch. Investors who bought stock in the early 2000s, not to mention the firm’s early investors, made out like bandits.

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But then tragedy struck with the death of Steve Jobs and the company entered a tailspin. Without this visionary figure, investors began to doubt whether the company could maintain its spectacular record of innovation and the resulting profit growth.

Legitimizing these fears, Apple soon started producing new products that missed the mark in terms of consumer taste, growth slowed, and even its world-class iPhone began to experience software issues. From mid 2012 to mid 2013, the stock dropped nearly -50%. Even now, well into mid 2016, the company is still trying to regain its former lustre as the undisputed king of tech. Apple’s stock price is down -2% year to date at the time of writing, slightly better than its -12% stumble earlier in the year.

Apple’s current woes include issues of reliance on iPhone sales, competition, and the difficult task of continued growth of a seemingly iPhone dependent company.

Forbes claims that the iPhone accounts for 66% of sales. Heavy reliance on one product is always a major risk and both the stock’s price and Apple’s key ratios reflect that. The company’s 2015 enterprise multiple was 7.55x, a decrease from 2014 and a substantial decrease from 2007’s 25.08x multiple. By contrast, Microsoft and Google’s multiples came in at 11.41x and 16.58x respectively. Post 2008, Microsoft and Google’s EV/EBITDA have gradually increased while Apple’s has slowly decreased.

Coinciding with the issue of iPhone dependency, competition among cell phone and tablet producers is high, with Samsung putting up the fiercest fight, and both Microsoft and Google battling hard in the computer and cloud computing space. Pressured from all sides, Apple must walk a delicate line to ensure that it releases only the highest quality products and that these products continue to revolutionize personal computing. Removing the headphone jack in the iPhone 7 shows continuous innovation - but is it enough?

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While incumbent Apple investors may be feeling some pain due to the company’s terrible stock performance in recent years, current valuations are a blessing in disguise for astute value investors. At Apple’s 2015 fiscal year end, the company’s PE ratio was 11.98x, significantly below the S&P 500’s 25x multiple. Microsoft and Google’s PEs were 29.83x and 34.08x respectively. These valuation multiples, combined with the mountain of cash the company has on its books sets up a decent chance for stock appreciation.

While it’s impossible to tell how Apple’s stock will perform going forward, stocks priced cheaply on a PE or an Acquirer’s Multiple basis tend to significantly outperform both the market and their peers. Legendary value investing firm Tweedy, Browne, found that stocks priced in line with Apple’s current valuations return roughly 14 to 15% over a 12 month period.

A company may hit roadblocks and stumble, but in the highly competitive industry of technology, this is a scenario that cannot occur often if they plan to sustain their dominance. Going forward, Apple must eliminate its dependence on iPhone sales as well as sustain growth. These statistics indicate Apple is slipping and not the perfect company investors once dreamed of.

Tim Cook can help investors by refocusing the company on its innovative roots, and Apple Watch is proof that this is starting. Slowly transitioning sales to other products will eliminate dependence on the iPhone and a number of products are shaping up to do just that. With the Apple Watch, Apple can produce applications and products to help end users monitor their health. With Fitbit, Apple is working closely with universities and hospitals to create apps that allow users to track their day-to-day health and maintain a healthy lifestyle. In effect, Apple is creating its own niche market.

Apple has also upgraded its iPad and MacBook products. The iPad in particular is now faster and lighter thanks to Tim Cook's solicitation of user feedback in order to construct better construct products.

Despite the attractive PE ratio and enterprise multiple, Apple must fix its problems by continuing to produce quality innovative products. The low PE ratio and decreasing EV/EBITDA is attractive due to the firm's strong iPhone market share & industry leading smartphone profitability. But, if the company shifts towards diversification, it can safeguard its revenue stream and resume a speedy level of growth - even despite its size. Apple’s stock price movement whenever new iPhone stats are released is evidence of the issue of having 66% of all sales attributed to the iPhone. According to Business Insider, in the 12 months after new iPhone launches, Apple’s stock price has rallied all but two times.

For a company like Apple, it will take something more then lower than average iPhone sales to take them out of the game. Investors should not ignore that fact, nor its increased awareness on new products, especially since this is a crucial way for Apple to diversify their income and continue to prosper.

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