Earlier today shares of Apple declined precipitously from down about 1% on the day to down a tad bit more than 6% in about a minute from 9:49am to 9:51am, before recovering a portion of the decline:
Not surprisingly short dated implied vol saw a massive intra-day spike rising 10 points, before settling in a bit, but still up about 5 points on the day:
While this seems fairly dramatic, I think that it is important to note that spot VIX is up about 10% today as well.
What’s interesting to me about this morning’s price action is that from today’s highs of $119.25 to today’s lows of $111.27, the stock lost almost $40 billion in market cap, or about 20% of this year’s expected sales of $210 billion.
AAPL shares are routinely thought of by the investment community as cheap on many earnings metrics (especially excluding their cash balance of $155 billion, equal to about 23% of their market cap). However, it is important to note that on one metric (one the company cannot easily affect through buybacks, as it can with earnings), Price to Sales (P/S), AAPL could be nearing lofty levels given the difficulty of seeing meaningful sales growth off such a large base.
The seven year chart below shows AAPL’s price to sales multiple vs the stock’s price, clearly showing approaching a fairly elevated level for the metric:
In the two years since AAPL’s stock first topped out in September 2012, the company has grown sales at an average of 8% a year. Analysts are now expecting a meaningful acceleration in fiscal 2015, which is largely the result of the launch of the two new iPhones, with a sort of unknown contribution from Watch and Apple Pay.
But here is the thing – analysts don’t see double digit sales growth lasting, as current consensus stands at about 6.5% growth in fiscal 2016 and 2017, per Bloomberg:
As the P/S ratio rises for AAPL, investors are likely making an implicit assumption that AAPL’s margins are going to improve (or at least remain the same) since each dollar of sales is worth more to the investor. Given AAPL’s large revenue base, and the increasing pressure of creating new categories to see a material sales bump, investors have been very focused on Gross Margin. The Gross Margin has actually declined about 5 points from peak margin in fiscal 2012 to last year’s 38.5%, which analysts expect to be flat for years to come, per Bloomberg:
So the real question for organic earnings growth, which analysts also expect to rise 20% in fiscal 2015, before dropping back to 10% in 2016 anbd 2017 is whether they can grow margins again? Bernstein Research analyst Toni Sacconaghi Jr contemplates this question in a note to clients dated November 13th:
we see three opportunities for margin expansion: (1) Apple Watch; (2) a mix-shift towards higher margin App Store revenues and away from lower margin iTunes; and (3) Apple Pay. We estimate that these three forces could collectively boost GMby 110 bp YoY in FY15 and by 50 – 100 bp over each of the following 2 – 3 years, the latter of which could offset ~100+ bp of annual erosion in iPhone gross margins.
That said, on a near-term basis, gross margins are more likely to be driven by more cyclical factors, such as warranty accruals and currency, both of which have had significant swings over time and are hard to predict. Longer-term, the iPhone – which is currently 60%+ of total company gross profit – is the biggest driver of margins. We believe iPhone margins are more likely to contract than expand going forward, as Apple looks to enhance the capabilities of the device (thereby raising COGS) in an effort to sustain its replacement cycle.
All that analysis has little to do with this morning’s volatility, aside from the fact that AAPL is a very crowded trade where investors seem quite complacent with the excitement about existing product cycles. From where I sit, I found all of the talk over the last few weeks of a path to $1 trillion in market cap a bit nauseating without outlining a path to growing sales by 30% in that same time period, despite expected growth of 10% for years following the current one.
At the very least we like the idea of using the spike in implied volatility to sell some short dated calls against long positions to add a wee bit of yield and create a little buffer to the downside, or as we detailed a couple weeks ago, put protection was under priced (Name That Trade – If You Have $AAPL Gains, Read This) and could be again soon if the stock were to settle in a bit.
Knee jerk reactions like we saw this morning in the largest market cap stock on the planet should be a bit troubling with the S&P500 just 1% from the all time highs. Just as it seemed unlikely to most in Sept 2012 that AAPL could have a substantial decline, it feels that the stock has fairly similar sentiment now. Again, not hating on AAPL, great company, great products, great stock, just trying to offer some realistic analysis after this massive run-up..