RealMoney Silver - Apple Likely to Stay Sweet

Apple Likely to Stay Sweet
By Bill Trent
RealMoney.com Contributor
9/17/2007 3:00 PM EDT

Few stocks boil the blood of both bull and bear as much as Apple (AAPL) , and for good reason.

The company, richly valued though it is, has come out with more cool products than the rest of the tech industry combined. That helps excite the bulls, and as for the bears, there's a good chance many of them are jealous for having missed out on the stock's run. They have sour grapes they hope will someday be pressed into wine.

And before you fanboys of some other tech stock get all hot and bothered about my disrespect of your favorite company's innovation record, allow me to summarily dismiss them.

Research In Motion's (RIMM) Blackberry? Great mobile enterprise email device. But that's for work. Ewww!
VMWare (VMW) ? See above. Not to mention it's hard to show off your virtual server.
First Solar (FSLR) ? Try this for a pickup line: "Hey, want to go back to my place and see how thin my solar film is?" Pass.
Google (GOOG) ? Still great at search. Nice email product. So what? They've spent more than a billion and a half on research and development in the last 12 months, and I dare you to tell me where it went.

As you can probably tell, I haven't gotten nearly enough hate mail recently, and I'm trying to kick things up a notch. So back to the task at hand: Apple. Let's quickly take a look at what I think are the best arguments on each side.

First up is whether the "halo effect" from the iPod is helping bread-and-butter Mac sales. Mac units were up 33% year over year, compared with just 12% for PCs overall. Bears counter that most PC makers (with the exception of industry leader Dell (DELL) ) had unit growth similar to the growth in Macs. But this ignores the very important point that Mac units sell for much more on average than the typical PC -- so in terms of revenue, share is likely growing much faster. Edge: bulls.

Next, is the iPhone a flop? When 270,000 units were sold in the first two days, I said "the 730,000 they are guiding to for the next three months seems laughably low." It is now looking as though that number was conservative. It is pretty clear the price cut was driven in part by a significant slowdown in sales -- possibly as low as 5,000 units per day by the time the suggested retail price was reduced, according to one convincing analysis.

But that would still put the iPhone in the same league as Palm (PALM) , even if not quite matching its original estimate of being in RIMM's league next year. But don't forget -- Apple got where it is now by being sold by one carrier in the U.S. As they roll out to other carriers on other continents, they could meet their target yet. It's not living up to the hype, but it is still a success. Edge: even.

Finally, the iPod -- a product that nobody seems to care about anymore, sold 10 million units last quarter when it hadn't had a product refresh in ages. Edge: bulls.

From an accounting standpoint, things are going so well at Apple that it is now deferring revenue from new products rather than booking it up front. This practice will help bake some growth into the cake. True, the company's earnings were boosted by a penny due to a lower bad debt reserve, but when you are beating quarterly estimates by a quarter, that is just chicken feed.

While the stock has nearly doubled over the last year, its free cash flow has more than tripled. As a result, a company that is growing at more than 20% per year on the top line is yielding 3.9% on a free cash flow to enterprise value basis.

The most significant risk in my mind, is the possibility of a consumer slowdown combined with increasingly high expectations. Apple is far more consumer-driven than other tech stocks, and a 40 times P/E multiple might not hold up if they only beat by a nickel, instead of the quarter investors have come to expect.

That's why I think the free cash flow is so important in this case -- it provides a solid backstop, and would help justify being patient through a slowdown should it come. If the company can grow at even half the current rate over the next five years, investors are likely to be well compensated for the added risk.