Inside the Madness: Why Can Apple Do No Right?
Research Director, Mad Money
From: James Cramer
Sent: Thursday, January 24, 2013 7:46 AM
To: Nicole Urken
Subject: AAPL, NFLX, AMZN
Let's look at earnings expectations / valuation of this group.
From: Nicole Urken
Sent: Thursday, January 24, 2013 7:52 AM
To: James Cramer
Subject: RE: AAPL, NFLX, AMZN
Will send along multiples for group—certainly dichotomy of growth vs value
Many investors have been scratching their heads after the earnings reports of Amazon (AMZN) and Apple (AAPL)—not to mention the recent meteoric rise in Netflix (NFLX), quite a contrast from its mid-2011 sell-off precipitated by its DVD pricing change debacle.
As the perception of Apple shifts from a 'growth' stock, which growth funds came after hand over fist, to a 'value' stock, is Apple now an opportunity? Put simply: At these levels, there is no doubt Apple is a compelling value at 10x forward earnings with a stand-out balance sheet, strong product cycle and enviable ecosystem of products. But with no catalyst right here, the stock is likely to remain in a trading range in the medium-term.
Let's take a closer look.
Emblematic of high-growth, high-multiple stocks? E-commerce behemoth Amazon which is currently trading at about 180x forward earnings.
This teflon stock can seem to do no wrong. After reporting a miss on Tuesday, the stock jumped higher despite its run-up and high multiple. This, of course, stands in stark contrast to Apple, which reported an EPS beat last week with generally inline results and immediately fell 12 percent, a conundrum we dove into on Wednesday's Mad Money episode.
Right now in technology, we are seeing a strong momentum trade. Ultimately, growth is being prized—and, in particular, investments in growth that are seen to have likelihood of paying off down the road.
Amazon is reflective of this, as the company has played out a strategy of high spending, as investors turn their heads at interim lackluster earnings and disappointing margins, a metric that improved this past quarter. The fourth quarter higher-than-expected gross margin of 24.1 percent was one of the very reasons the stock shot up after the report, as the reported margin expansion suggests the company's investments are paying off.
Now, one of the reasons that investors have given Amazon the benefit of the doubt when it comes to investments? The company remains THE behemoth in e-commerce.
With almost 20 percent market share in the US, the fragmented universe of other players has resulted in the lack of a viable competitor. Not to mention that the e-commerce penetration relative to overall retail sales remains astoundingly low – about 6 percent in the US and significantly smaller internationally.
When we originally touted the upside in Apple, we looked at the market share it was 'stealing' from a range of sectors including PC-oriented companies Dell (DELL), Hewelett (HPQ) and Microsoft (MSFT), advertising names like Google (GOOG), feature-phone players like Motorola (MOT) and Nokia (NOK), and less-well-positioned smart phone names like Research in Motion (RIMM).
Amazon has this 'market share' stealing upside across the brick & mortar retail space from electronics to home goods to clothing and more. In fact, many of the retail analysts have started to rank their stocks based on 'exposure to Amazon' or 'relative defensive position vs Amazon.'
Apple, on the other hand, has Samsung biting at its heels in terms of market share. This calls into question pricing power (average selling prices—ASPs) and the sustainable growth of the product cycle for iphones, ipads, ipad minis, Macs and beyond, with worries even of intra-company cannibalization. Not to mention that while smartphone penetration still has a long way to run, the runway is not nearly as impressive as e-commerce. Right now, of the 5 billion mobile devices out there, about 30 percent are smartphones. In other words, while there is much run room ahead, it pales in comparison to the e-commerce upside.
So what do investors want to see from Apple? Innovation—revolution not evolution. And putting its $137 billion of cash (which it is getting minimal credit for) to work! Why do they want to see this? Because they don't want Apple, albeit currently trading at a dirt cheap multiple, to become a legacy of the past or to lose out to peers. Remember, one way to play smartphone growth without having to choose an original equipment manufacturer (OEM) winner is through the chip suppliers, like Broadcom (BRCM) and Qualcomm (QCOM)—both well-positioned.
At this point, especially after the recent run-up in shares, investors are reacting to Wednesday's quarterly report with mixed signals, noting that the company remains in 'show me' mode as it hasn't established its runway vs competitors. Of course, the notion of growing profitably ultimately is key, as SAP (SAP) Co-CEO Bill McDermott told Jim Cramer on Mad Money Thursday.
After all, none of these names want to become the Hewlett Packard, trading at 5x P/E, Dell, trading at 8x even after takeout chatter, or Microsoft at 9x —all of which have under-invested and missed the boat of growth opportunities.
In the end, it all comes down to investing to remain ahead of the competition.Netflix CEO Reed Hastings saw in mid-2011 that the company would have to start investing in content to shift to more streaming, but the stark and sudden DVD pricing increase to fund these investments caused the stock to plummet from $300 to under $100.
Now that Netflix is showing some traction in subscribers with some marked improvement in streaming, it is making its way back. (The high short interest also aided its post-quarter surge last week). After the big run, I would await for a more attractive entry point to come in, but it certainly the company showing some more traction in terms of subscribers and, importantly, reflects the trend of investors rewarding investment and growth.
Another note: Don't mix up the notion of a short-term trade and a longer-term investment. Research in Motion (RIMM) was a winning trade running into the end of January as opportunities were thrown around about software licenses, not to mention this week's BB10 'effort to remain relevant' product launch. But this name does not represent value at these levels, and it is certainly not in growth mode. Be wary of this one outside of a short-term trade. Same goes for Nokia or Sony (SNE)–struggling legacies of the past that have had some short-term runs but are not well-positioned investments.
The bottom line: In tech, investors want to see companies investing in the right way to be aligning themselves for relevance and growth in the future.