Apple products & Dell stock

Apple, Inc seems to be the rage not just with design-conscious young consumers but also with the hedge-fund crowd. Many famed investors including David Einhorn, (see here) are holding and talking up Apple stock resulting in its remarkable performance over the last few years. Its stock is up 32% in the last 12 months and some 184% since April 2009.

In all fairness Apple scores favourably on two out of three criteria for profitable stock selection, as it represents a high quality franchise with attractive growth prospects. Focusing on the “quality” component, it would be hard to argue against this behemoth, trend-setting company. For the last decade, all of its product launches have been runaway successes shaping the technology and entertainment industry.

Starting with the ubiquitous Ipod family of products, followed by the ground-breaking- Nokia-killing Iphone and ending (for now at least) with the category–creating Ipad computer, Apple has delivered a run of hits unparalleled in recent corporate history. Management too has been both stable and focused, led by the visionary that is Steve Jobs and his trusty and effective lieutenant, Timothy Cook. Add to this a set of world class engineering and design talent, motivated to work in one of the most admired companies in the world and you have the ingredients for a classic virtuous circle of quality.

On the growth front, and despite its stellar run in the 21st century, ample space remains. Apple’s products derive industry-leading margins and continue to be priced at the higher end of the spectrum. Even minor price concessions or an extension to the current distribution partnerships (especially in the area of mobile telephony) in place in the US and Western Europe would likely deliver huge sales unit growth. And bear in mind, that Apple’s footprint in large, growing markets like China and India is currently extremely low.

The third leg of the above mentioned criteria, valuation is however, where Apple stalls. Much as I, and pretty much everyone I know, love this company, its products, stores, branding, design and user experience, I am not inclined to extend my purchasing to its common stock. Apple trades, as of the date of this writing, at a lofty 18x Earnings-Per-Share (EPS) on a trailing basis and its market capitalization represents 5,5x its accounting book value. Even allowing for the fact that book value if of little relevance to companies outside financial services with large amounts of intangible goodwill, as is certainly the case with Apple, 5,5x seems unwarranted.

A further source of concern for the potential investor ought to be the implicit growth expectations built into its current price. Admittedly, as pointed out earlier, opportunities to grow abound but not at the level expected or “priced-in” by the market. To illustrate this point, note that Apple’s Fiscal Year 2010 revenue topped $ 76 Billion growing 54% year-on-year. To merely maintain this momentum would mean finding an additional $ 41,1 Billion in new sales, no mean feat in the current macroeconomic climate!.

Taking the other side of the trade however, is not really an option either. Shorting Apple at this stage and with its stellar balance sheet (low debt , $ 27 Billion cash balance and annual free-cash flow of $ 6 Billion), would not be wise.

Faced with this conundrum I offer some food for thought in the (almost) same space. How about DELL?.

The corporate leader in IT solutions sports:
1. an attractive 10x P/E ratio 2.
$ 10 Billion in net working capital (excluding inventories, of course)
3. A hugely valuable brand
4. a less-fickle target market (corporations with large cash balances)
5. It is, once again, run by its remarkable founder, Michael Dell.

I will certainly be looking at DELL more closely.