AAPL: Buy; PT $160; 3Q15 Update

AAPL: 7/27/15; $122.66

From Thomson Reuters I/B/E/S Estimates:

Forward Earnings: 9.45

Forward PE: 12.98

Earnings Growth Rate (EGR): ~10%

PEG Ratio: 1.30

S&P Forward PE: 17.82
S&P EGR: 7.16%

AAPL reported earnings on Tuesday, July 21, and...it was another great quarter.  Revenue in China increased over 100% year-over-year (y-o-y), Apple Watch sales exceeded management's expectations (whatever they were), and a staggering amount of iPhones were sold (and at an average price of $100 more than a year ago).  As is customary with AAPL's quarterly reports, it just wasn't quite good enough for the analyst community, and the stock dropped over 5% on the day following the report.

So what was the beef about this time?  iPhone sales in China.  Although iPhone sales increased by 35% relative to the year ago quarter, unit sales did not meet analyst's expectations.  The "miss" was attributed, with no basis that I've come across, to slowing sales in China.  China's stock market has recently suffered a pretty significant decline, and fear is that potential iPhone buyers have lost a significant amount of spending money due to this decline.  Apple CEO Tim Cook had this to say during the quarter:

"Nothing that's happened has changed our fundamental view that China will be Apple's largest market at some point in the future...I think this is a major point that many people miss, the LTE penetration in China is only at 12%.  And China doesn't possess the level of fiber that some other countries do...Also, and I can't overstate this, the rise of the middle class there is continuing, and it is transforming China.  McKinsey, I saw a recent study from McKinsey that's projecting the upper middle class to grow from 14% to 54% of households over the ten-year period from 2012 to 2022."

The China worry has some logic to it.  Even though their market is up 90% over the last year and 20% year-to-date, volatility can create a lot of losses for the buy-high-sell-low crowd.  However, smartphones have become more of a necessity than a luxury these days.  People will find a way to buy an iPhone if they are in the market for it.  Also, as Tim Cook points out, China has enormous growth ahead of it in the smartphone market, as most of the China network does not have LTE capabilities.  The long-term prospects for Apple in China far outweigh any near-term concerns, at least that's Common Cents's opinion.

China concerns aside, gosh what an awesome quarter.  And AAPL is valued below the average S&P company?!  We still maintain that AAPL's earnings will more likely accelerate than decelerate.  And so far, 33% y-o-y revenue growth and 45% y-o-y profit growth flies in the face of the "law of large numbers" theory.

Common Cents maintains that Apple is an attractive buy and would be fairly valued at a share price of $160, assuming a PE ratio of 17.0 is conservative given the great culture, long-term track record, potential for major breakthroughs in growth, and ability to return cash to shareholders if growth slows.  The assumed PE is below the current high-17 PE of the S&P, as we see the potential for a "correction" (sell-off) of the overall market after its extended duration of growth.  In addition, the lower assumed PE of AAPL is warranted given the polarizing nature of this position with investors.

Going forward, I hope to sell part of Common Cents's position to reduce the position to its target allocation when the share price nears $140.  Any pull-backs to $121 or below will create an attractive opportunity to trade an options contract.

Common Cents Take: Apple crushed this quarter.  Any China worries represent short-term thinking that does not consider the long-term growth prospects.  It is hard to argue that Apple is worse than the average company in the S&P, especially considering the 30%+ growth shown this quarter, which is what its current PE multiple suggests.