September 16th, 2009

Cramer and AAPL (Apple)

I need to vent to you about Cramer again. I hadn’t seen the show for a while but caught him make a fool of himself again tonight. I shouldn’t really get so upset because by making no logical sense he actually presented a pretty good case for individual investors, or “home gamers” as he likes to call us, to totally dismiss fundamental analysis and adopt technical analysis instead. You have to follow me on this because it’s a beautiful example of why his dictum that you have to “do your homework” is absolutely meaningless and the only things that matter are price, volume, trend and momentum.

What I’m talking about is his red “apple/green apple” (you had to see his show to understand his metaphor) argument about why he was upping his price target for Apple (AAPL) from 200 to 264 (closed today at 175.16). He said his old target no longer applies because of an upcoming change of accounting. As summarized on theStreet.com, the FASB (Financial Accounting Standards Board) accounting change involves:

“how Apple can recognize revenue from its popular iPhone and less popular AppleTV products. Current rules force Apple to recognize this revenue over a 24-month period, meaning that sales today cannot be fully recognized for a full two years. This rule is antiquated and just plain dumb, said Cramer, as it treats Apple differently just because it makes a smarter phone with better software. Meanwhile, rivals like Nokia, which apparently make ‘less-smart’ phones, are immune to the rule, he said. Cramer said if Apple is allowed to recognize all of its true earnings, those earnings will skyrocket from an estimated $9 a share in 2011 to $12 a share. Given these new earnings, Cramer said his new price target for the company is now $264 a share.”

Cramer went on to claim that this is the time the individual investor should get on board “before Wall Street catches on” because most of the analysts “simply look at the ‘first call’ estimates, and have not taken the time to dissect what this rule means for Apple’s earnings.

So “fundamental analysis” tells us, according to Cramer, that the value of a stock should be 30-40% higher merely because the FASB changed some accounting rule? If there were an accounting rule change that, hypothetically, reduced their earnings by 50% would the stock be worth 50% less (remember all the debate about “mark to market” and the impact that rule had on bank earnings)?

Here are the fallacies of his whole line of reasoning:

  1. When there is an accounting change, earnings are usually reported both the old and the new way so those looking at the financial statements can see the impact of the accounting change and reverse out the adjustment from their valuations.
  2. There can be just as valid an argument made, actually more so, that AAPL’s price earnings multiple should be reduced going forward from 20 to 15 as there is to keep the PE ratio at 20 and increase the price target from 200 to 264 to reflect for the change in accounting.
  3. For the individual investor, earnings projections and price multiples are theoretical …. something someone uses to justify their decision to buy or sell a stock to an investment committee. The only fact that can be counted on is the last price paid for the stock and how that price compares with the price paid last week, last month, last year.
  4. The only reason AAPL’s stock price will reach 264 is if the demand for the shares outstrips the supply of shares offered forcing buyers to pay higher prices. Investors will demand those shares for an untold number of reasons:
    • liking the products; liking the ads;
    • giving the stock as birthday, graduation, Bar and Bat Mitzvah gifts;
    • hearing stories from those who bought the stock 4 years ago at 30 and still holding on to it;
    • Asian investors who want to own American stocks and the one name they know is Apple;
    • an investment committee who asks why Apple isn’t in the retirement trust fund when they’ve heard so much about how strong the stock has been
    • …. and on and on.

So what does the picture actually look like?

Without a doubt, Apple has been an unbelievable stock since iTunes and Ipod launched around 2004 and the stock was under 10. But since peaking in December 2007, AAPL has formed what so far is a “bull flag” pattern. All this year, even as the stock doubled, volume has been anemic.

Will the stock be able to pierce the resistance at the all-time high without a significant boost in demand volume [perhaps that’s why Cramer came out to pump it up]? Probably not. The stock is extremely extended ahead of its 200-day moving average and the 300-day hasn’t turned positive yet. My guess is that it will retreat in sync the next market correction (when the S&P-500 hits around 1080-1125) and the move to new all-time highs will come in and when the bull market resumes …. and not as a result of an FASB accounting change.

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  • Ticker Street

    FASB rule change is only seen by dumbers and retail. The hedgies are smart, everytime AAPL reports – they look at the number of macs sold, number of iphones sold, ipods sold etc. Lol, FASB accounting change cannot change this. So, it doesnt make any difference for hedgies, this rule change is already baked in. Buy the rumor, sell the news!

  • Anonymous

    Guru, how do you tell that APPL (or any other stock) is too far ahead of 200 day moving average? Is there a rule of thumb level like 5 or 7% above? thanks

    Mark

  • Guru

    One rule of thumb for judging when a stock is "ahead of itself" (or behind, for that matter) is to measuring how far above (or below) the stock is from its 200-dma. The convention is a band of 3 standard deviations.

    Since 2000, for example, AAPL has never strayed much above that 3-std. dev. band for very long. In 2008, the band acted as one of the barriers preventing the stock from going higher (in addition to the financial crises crash). In 2009, the stock the band helped to break the stock's fall at 85.

    While the band moves up along with advances in the stock and the 200-dma, it does indicate an "over-bought condition". The stock may not reverse but its advance probably will be slowed or temporarily stopped for consolidation.

  • Minnesotalee

    I've got AAPL as a buy with a PO of 231.

  • Daniel

    From my extensive analysis on Apple, Cramer is being conservative. People were naysaying Apple when it was trading at 80 a couple years ago. This is a freight train, and its no fun getting out in front of a freight train. So hop on…..

  • Ed Dinovo

    Random thoughts on AAPL:
    • The iPad did not materialize at their 9/9/09 event. Major downer.
    • What we’ve seen w/ iPhone is growth on top of growth. Smartphone market is expanding, and AAPL mkt share was expanding. Yes, the Smartphone mkt is guaranteed to grow, but AAPL’s mkt share is not. Also, their margins are sure to erode further.
    • AAPL products tend to be luxury goods. They are the *it* brand and have maintained the caché throughout the recession so far. With unemployment as it is right now, I don’t think as many consumers will be ‘trading up’ to Apple. Yet, their sales have maintained with the haute couture fashion crowd.
    • Fundamentally, how many years of growth on top of growth are already baked into this thing?
    • Technically, I’m looking for a quadruple top around the 190 level. Although, a breakout towards the all time high could also happen – either way, volume will need to be there to convince me of sustainability.