Spare a moment of pity for the Apple (Nasdaq:AAPL) bears and shorts, as they have another difficult day ahead of trying to get over their cognitive dissonance. Simply put, this company remains a remarkable force in consumer technology, and seems to have an uncanny ability to create its own markets. The Gordian knot for Apple investors, then, is trying to make their peace with a valuation that suggests Apple may just be worth a truly breathtaking amount of money.
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A Great Start to the Year
Apple certainly had a good Christmas. Revenue in the fiscal first quarter jumped 73% from last year and 64% from the prior quarter, and did some very bad things to the prior analyst guesses. Revenue was largely strong across the board - PC sales were up 22%, iPhone sales were up 133% and iPad sales were up 99%, while iPod sales declined 26% year-on-year.
This company also did a great job of continuing to deliver top-notch profit leverage. Gross margin grew more than six points, helped by double-digit declines in DRAM and NAND pricing. Operating income more than doubled (up 122%) and the operating margin grew more than eight points. (For related reading, see What We Can Learn From Steve Jobs.)
So ... Now What?
Certainly Apple got a benefit from pent-up demand for the next iPhone, and iPhone unit sales jumped 128% from last year. But, it wasn't like the other products were chopped liver; PC units rose 26% and iPads rose 111%.
What Apple is doing, then, is achieving growth in markets that are largely terrible for everybody else. Companies like Hewlett-Packard (NYSE:HPQ) and Dell (Nasdaq:DELL) can't seem to do much with their PC businesses, while HP, Research In Motion (Nasdaq:RIMM) and most others struggle to get much traction with their tablet products.
But there's no reason to think that momentum is about to smack into a brick wall. True, the iPhone won't have that same pent-up demand in this next quarter, but take into consideration that the product hasn't yet rolled with the largest cell phone company in the world (China Mobile (NYSE:CHL) and its more than 600 million subscribers.
It's also true that the memory market seems to be bottoming and that companies like Micron (Nasdaq:MU) and Samsung may not see such sharp price declines. Then again, it's not like the overall trend in memory and component costs hasn't been steadily down for decades.
The Cash Question
Whatever and whenever the Apple TV product becomes, it's not going to take much money to develop, produce or market. The question then becomes what Apple may do with all of this cash. At this point, the company could launch an R&D plan to develop robotic monkey butlers and it wouldn't make any difference.
A regular dividend, one-time special dividend or share buyback would all be conventional options for that cash. There's also a chance that Apple will direct more cash toward acquisitions, but it's hard to see obvious targets. Why buy a company like Netflix (Nasdaq:NFLX) when it can basically design around it? Likewise, why buy component companies? Apple clearly benefits from the innovation and cost savings that are unlocked by having companies compete for their business, so would there really be advantages in buying business that current management really has no experience running?
The Bottom Line
It feels quasi-ludicrous to talk about price targets on Apple because the numbers get so big so easily. Take the fiscal 2011 free cash flow and grow that at between 4 and 5% over the next decade, add the cash and you get a target near $600. But 4 to 5% growth seems like quite a conservative outlook given what the company is doing with sales and margin expansion. (For related reading, see Steve Jobs And The Apple Story.)
Although it is likely that Apple's returns and margins will decline, as there just aren't that many markets where the company can generate similar margins, the current valuation already seems to bake that into the numbers. Apple is admittedly a bizarre stock right now, but it doesn't seem to pay to bet against it at this point.
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At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.