On May 11, Apple stock ($AAPL) continued its post-earnings descent. At one point, shares traded as low as $123, nearly erasing all second quarter gains. At those levels, the stock was down 14% from its January 2021 all-time high.
While it is all but impossible to anticipate market movements with much precision, the Apple Maven presents below a framework that investors can use to think about the downside risk in Apple share price. How low could it go from here?
Apple stock: thinking in P/E terms
Price-earnings (or P/E) is a common relative valuation metric used by investors: stock price divided by annual earnings per share (or EPS). Algebraically, therefore, one can define stock price as forward P/E times projected earnings.
While it has its imperfections, the valuation multiple can help investors think of a stock’s price in the context of its two key variables:
- How much a company can or will produce in financial results – in this case, net income;
- How much the market is willing to pay today for future financial performance – the P/E multiple.
Fundamentals look solid
When it comes to financial results, what investors have seen from Apple lately is nothing short of impressive. The Cupertino company blew expectations out of the water in fiscal second quarter, posting strong double-digit growth rates across all product and geographic segments. The management team’s partial guidance for fiscal third quarter also looked highly encouraging.
To be fair, Apple will face tough comps through the balance of 2021. Also, App Store sales could come under pressure, especially in the short term. Other experts on Wall Street go further and point at policy and regulatory factors possibly causing a drag on Apple’s bottom line.
But at a higher level, the business seems to be in top shape, with demand for Apple products and services at a high. Analysts’ expectations have been revised up as a result: previous 2021 EPS forecast of $4.45 has shot up to $5.16 in the past couple of weeks.
The first bullet point above, therefore, does not seem to be a major concern for Apple, certainly not in the short term.
The problem: willingness to pay
The bigger risk to Apple share price, in my view, comes from the second bullet point.
Even if Apple “delivers the goods” (in this case, earnings), the market may still not be willing to pay a high price for them today. The culprit could be inflation worries triggering higher interest rates and discouraging investments in tech growth stocks. This is what seems to have happened in the past few days.
The good news is that valuations have already come down substantially in the past few weeks. Just before fiscal second quarter 2021 earnings day, Apple shares traded at about $135, suggesting a fairly rich current-year P/E of 30 times ($135 divided by EPS estimate of $4.45).
As of late morning on May 11, the multiple had dropped to only 24 times: $125 per share divided by new EPS consensus of $5.16. In other words, Apple stock’s valuation has already returned to pre-pandemic levels, working out some of the “froth” that investors might have been worried about.
It is hard to tell how much further valuations could dip from here. But while Apple’s P/E could certainly head into the low 20s for the first time in a while, I think that the potential reward of investing in the company’s equity increases as (or if) the multiple ticks lower.
I asked Twitter for an opinion on what happens to Apple stock next. Could we see a steeper correction, or a V-shaped recovery? Below are the answers.
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(Disclaimers: this is not investment advice. The author may be long one or more stocks mentioned in this report. Also, the article may contain affiliate links. These partnerships do not influence editorial content. Thanks for supporting The Apple Maven)