Apple: Lock In Gains Before They Evaporate

Summary:

• After surging to new all-time highs in July on the back of Apple Intelligence hopium, AAPL stock has been trading sideways, with momentum indicators rolling over.
• Despite its AI potential, Apple’s reliance on third-party LLM models and lack of groundbreaking innovation raise concerns about its future growth trajectory.
• While Apple stock is priced for 20%+ growth in coming years (as seen through reverse DCF), consensus analyst estimates continue to hover in the single digits.
• Warren Buffett is selling aggressively, and I continue to rate Apple as a tactical “Sell” at current levels due to poor long-term risk/reward.

Introduction

Back in June 2024, I highlighted the AI euphoria in Apple (NASDAQ:AAPL) stock as a selling opportunity for investors:

By striking a deal with OpenAI [owned 49% by Microsoft (MSFT)] to bring ChatGPT to Apple’s ecosystem (Siri in particular), Apple is simply catching up with its big tech peers like Microsoft and Alphabet (GOOG) (GOOGL). While privacy-focused Apple Intelligence is proof that Tim Cook and Co. are trying to get their house in order, none of the GenAI features announced at WWDC were truly groundbreaking. Apple’s promise of privacy is great, but I remain skeptical about an AI-driven supercycle for Apple until data shows otherwise.

Since WWDC, multiple Wall Street analysts have raised their price targets for Apple stock, citing its AI potential. However, as I see it, Apple relying on third-party LLM models to power Apple Intelligence exposes a lack of innovation at the iPhone maker.

More importantly, consensus analyst estimates for Apple’s near-term revenue and earnings [EPS] still indicate low-single-digit y/y growth in upcoming quarters, and revision trends remain mixed!

As a result, the entirety of Apple’s latest run up from the $160s to the $210s is directly attributable to an expansion in trading multiples, with AAPL’s forward-PE ratio going from ~25-26x to ~32-33x over the last few weeks.

As of today, Apple’s hardware and software ecosystem is unbeatable; however, the DOJ’s lawsuit against Apple is a wildcard that threatens this sustained competitive advantage. Hopefully, the antitrust overhang will accelerate Apple’s journey to its fair value – creating a worthwhile buying opportunity for long-term investors. Given Apple’s lousy growth numbers, I still think we will get an opportunity to buy Apple at or below fair value within the next 12-24 months.

Currently, I have no position in Apple stock. Warren Buffett is selling, and I think you should too!

Source: Apple: AI Euphoria Is A Selling Opportunity

Since then, AAPL stock has risen from ~$215 to ~$230 per share – slightly outperforming the broader stock market [i.e., S&P 500 (SPY)] in the process.

Now, if you have been following my work on Apple, you know that I turned bearish on AAPL stock at ~$175 per share last year, and have since published 6 “Sell” ratings on the Cupertino tech giant.

Have I been wrong to suggest profit-taking? The 30%+ rally in Apple stock screams – “Heck, yeah”!

Mr. Market clearly disagrees with my somber view on Apple; however, one of the greatest investors of all time – Mr. Warren Buffett [Berkshire Hathaway (BRK.B) CEO] seems to agree with me. In the past three quarters, Berkshire Hathaway has sold 516M AAPL shares, trimming its stake by ~56.33%, in an increasingly aggressive manner!

	Previous Share Holdings	Change in Share Count	New Share Holdings
Q4 2023	916M	-10M	906M
Q1 2024	906M	-116M	790M
Q2 2024	790M	-390M	400M

Click to enlarge

Mr. Buffett has a longer holding period than most investors, and Apple is a business he labeled as a “better” business than American Express (AXP) and Coca-Cola (KO) in May 2024.

Then, why is he selling Apple stock so aggressively?

While there are a lot of theories floating around the Internet, I believe the simple answer is poor long-term risk/reward offered by AAPL stock at current levels. Please understand, Apple is an incredible business. The problem is that investors cannot justify paying ~34-35x earnings for a mature business growing top-line at a single digit y/y growth rate.

As we have discussed in the past, negative equity risk premiums are unsustainable. A significant decline in long-duration treasury yields has boosted Apple’s equity risk premium, but it is still in the negative territory. This means AAPL’s current valuation is simply unsustainable.

To understand this idea from a different perspective, let’s perform a reverse DCF analysis on Apple.

Apple Reverse DCF Model

For this exercise, I modeled AAPL stock with a 2024E revenue base of $390.51B [up from $381.62B], and assumed an optimized FCF margin of 30% [significantly higher than current margins]. All other assumptions are straightforward and self-explanatory, but if you have any questions, please share them in the comments section below.

For a detailed explanation of these assumptions, refer to –

• Apple: AI Euphoria Is A Selling Opportunity

According to this reverse DCF model result, the market is currently pricing a 5-year CAGR sales growth rate of 20.76% into Apple’s stock! While Apple has delivered such growth in the past, consensus analyst estimates for 5-year CAGR sales growth rate currently point to a high-single digit growth rate.

Hence, there’s a spectacular mismatch between business realities (as measured by several Wall Street analysts) and market pricing of AAPL stock.

Can Warren Buffett, Ahan Vashi, and Wall Street analysts be wrong? Sure, forward estimates can be wrong for Apple or any stock out there. However, Apple has struggled to deliver top-line growth in recent quarters, and it is unlikely to get anywhere near the 20%+ growth priced into the stock. There’s no clear needle-moving product in the pipeline. As you may know, Apple has already dumped its Electric Car project, cut Vision Pro production for 2024 and 2025 due to low demand [focusing on lower-priced model], and recently cut production on iPhone 16 – signalling a lack of consumer enthusiasm for Apple Intelligence and throwing cold water on the idea of an AI supercycle.

In my previous report, I shared the following:

Apple is an incredible consumer products and services company that will continue to make billions of dollars in free cash flow every year; however, in the absence of growth, justifying a premium valuation such as the one commanded by AAPL stock is becoming increasingly difficult for investors. And in my view, this is why AAPL stock has massively underperformed its big tech peers so far this year.

Now, a high-moat business like Apple can certainly command an above-market multiple through a temporary growth slump; however, Apple’s future growth trajectory is a blur at this point due to the lack of a clear needle-mover. With Sam Altman (OpenAI’s CEO), Jony Ive (legendary iPhone designer), and Tang Tan (former Chief of Design at Apple) reportedly working on a new consumer AI device, for the first time in a very long time, there are questions around Apple’s dominance getting gazumped by the AI revolution. As you may know, Apple recently canceled its autonomous EV project to focus its efforts on GenAI, and now Apple is apparently in talks with Google to license Gemini AI for the next iPhone! Given Google’s botched AI product launches over the past year, Apple’s decision to partner with them reeks of desperation.

Under CEO Tim Cook’s leadership, Apple’s business and stock have gone from strength to strength, with incremental improvements across products and services, but Apple’s innovative DNA seems to have been lost with the loss of Steve Jobs. While Apple can still play a vital role in the fourth industrial revolution [AI], the Cupertino giant needs to get the house in order quickly and start delivering disruptive innovation again. The Vision Pro is a good start, but we still need to see a lot more data to trust the face computer as the next needle-moving product or platform for Apple!

By striking a deal with OpenAI [owned 49% by Microsoft (MSFT)] to bring ChatGPT to Apple’s ecosystem (Siri in particular), Apple is simply catching up with its big tech peers like Microsoft and Alphabet (GOOG) (GOOGL). While privacy-focused Apple Intelligence is proof that Tim Cook and Co. are trying to get their house in order, none of the GenAI features announced at WWDC were truly groundbreaking. Apple’s promise of privacy is great, but I remain skeptical about an AI-driven supercycle for Apple until data shows otherwise.

Since WWDC, multiple Wall Street analysts have raised their price targets for Apple stock, citing its AI potential. However, as I see it, Apple relying on third-party LLM models to power Apple Intelligence exposes a lack of innovation at the iPhone maker.

More importantly, consensus analyst estimates for Apple’s near-term revenue and earnings [EPS] still indicate low-single-digit y/y growth in upcoming quarters, and revision trends remain mixed!

Now, the three-month revision trends for consensus analyst estimates paint a mixed picture, with Q4 revenue estimate up by +1% and EPS estimate down by -0.8%. Overall, both revenue and EPS trends for Apple have been positive, i.e. Wall Street analysts are getting more optimistic on the Cupertino tech giant’s business.

That said, this minor uplift in consensus estimates for revenue and EPS fails to bridge the massive mismatch between business expectations [of 7-8% y/y growth] and the unrealistic growth [of 20%+] priced into Apple’s stock.

What Is Apple Worth?

Despite Mr. Market’s excitement around Apple Intelligence, I am sticking with realistic assumptions for future revenue growth and optimized FCF margins to determine Apple’s fair value and expected returns.

Here’s my updated valuation model for Apple:

Last quarter, Apple beat top and bottom line expectations. As a result, I have lifted my 5-year CAGR sales growth assumption from 5% to 7.5%, moving it in line with consensus street estimates. All other assumptions from our previous assessment have been held, if you do have any questions, share them in the comments section below.

Now, TQI’s fair value estimate for AAPL stock has moved up from ~$119 per share to ~$136 per share; however, with Apple trading at ~$230 per share, I see a downside of -41% to fair value.

Furthermore, assuming a base case exit multiple of ~20x P/FCF, I can see Apple rising to $273 per share by 2029 at a CAGR rate of ~3.5%.

Since Apple’s expected CAGR return is lower than our investment hurdle rate of 10% for low volatility, high quality stocks, long-term S&P 500 (SP500) annual return of 8-10%, and risk-free treasury yields of 4%+, I continue to view Apple stock as a tactical “Sell” at current levels.

Concluding Thoughts

The efficient market hypothesis is a fallacy, as stocks could easily get detached from their intrinsic values and stay at elevated or depressed levels for long periods of time. And, Apple sustaining a negative equity risk premium over the last 12-18 months is a great example of Mr. Market’s irrationality.

As visualized through today’s reverse DCF exercise, Apple’s stock is priced for 20%+ CAGR sales growth for the next five years. With consensus analyst estimates sitting in the high single digits, I think it is fair to say that Apple stock is baking in unrealistic growth!

Mr. Buffett understands this dynamic, and has already disposed more than half of his Apple position in recent quarters. While Berkshire’s 13-F filing for Q3 (due 15th August 2024) will be revealing, I wouldn’t be surprised if Buffett & Co. report more selling activity of AAPL stock.

From a technical standpoint, Apple seems to be losing momentum, with weekly RSI rolling over from overbought territory (>70), along with price – after a period of bearish divergence between AAPL price and RSI.

While Apple is sitting close to its all-time highs, a breakout seems unlikely due to stretched valuations [Apple’s current P/FCF of ~33x > 2021 peak]. Are we forming a double top? Only time will tell. That said, based on long-term risk/reward, Apple is still a tactical “Sell” for prudent investors.

Key Takeaway: I continue to rate Apple a tactical “Sell” at ~$230 per share.

Thank you for reading, and happy investing! Please share any questions, thoughts, and/or concerns in the comments section below or DM me.

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Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.

Seeking Alpha’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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