Apple's Valuation Debate Begins

After a stellar quarter propels the stock higher, analysts begin to question how much upside is left.
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Updated from 9:44 a.m. EST

Apple's

(AAPL) - Get Report

bountiful holiday quarter gave its stock a growth spurton Thursday. But analysts differed on whether the share price wouldcontinue to grow or taper off.

In recent trading, the company's shares were up $6.35, or 9.7%, to$71.81.

Prudential's Steven Fortuna had one of the sunniest forecasts,pushing up his price target to $93 from $75, andupgrading Apple to an "overweight" rating from a "neutral."

"Although we typically are not reactive to company earnings, we aretaking exception here as a result of the magnitude of the upsidesurprise and the accompanying upward revision to earnings. We believethat the company may have begun a market share breakout story thatcould last for the foreseeable future," Fortuna said in a research noteissued on Thursday.

(Prudential has not done recent investment banking business forApple.)

But others saw little upside in the stock after its big run onThursday morning. Harry Blount at Lehman Brothers, for instance, tookhis price target up to just $73 from $66 and maintainedhis "equal weight rating on Apple shares.

"While we believe that Apple will maintain strong product momentum,we believe the flow of good news has likely peaked short-term.Therefore we are increasingly wary of valuation," Blount said in areport on Thursday.

(Apple has been a noninvestment banking client of Lehman in thelast year.)

In its first quarter ended Dec. 25, Apple earned $295million, or 70 cents a share. That was more than quadruple the $63million, or 17 cents a share, the company earned in the same quarter ayear ago.

Sales at the Cupertino, Calif.-based company jumped 74% to $3.49billion.

In contrast, analysts had predicted that Apple would post earningsof 49 cents a share in its just-completed quarter on $3.18 billion insales, according to Thomson First Call. And it was above the guidanceApple gave in October, when the company projected it would earn 39cents to 42 cents a share on sales ranging from $2.8 billion to $2.9billion.

"We are thrilled to report the highest quarterly revenue and netincome in Apple's history," Apple CEO Steve Jobs said in a statement.

For the second quarter, the company said it expected to earn 40cents a share on revenue of $2.9 billion.

Analysts have forecast that Apple will earn 33 cents a share in itscurrent quarter on $2.74 billion in sales. For the full year, analystshad predicted Apple will earn $1.53 a share on sales of $11.75 billion.Last fiscal year, the company earned $276 million, or 71 cents a share,on $8.28 billion in sales.

Apple's announcement followed the closing bell on Wednesday.Earlier in the day, Apple shares closed regular trading higher by 90cents, or 1.4%, to $65.46.

The company's results were driven by sales ofits iPod digital-music players. In the quarter, Apple shipped 4.58million of the devices, up from 733,000 in the year-ago quarter. Interms of revenue, the company saw $1.2 billion in iPod sales in theholiday period, compared with $537 million in its fourth quarter andjust $256 million in the year-prior period.

"This was an unprecedented quarter for the iPod," said company CFOPeter Oppenheimer on a conference call.

But Apple also saw a surge in computer sales in the quarter. Totalsales of the company's Macintosh line increased to 1.05 million units,from 829,000 in the year-ago period. Revenue from those sales jumped to$1.61 billion in the holiday period, up 30% from the company's fourthquarter and 26% from its year-earlier quarter.

Apple's strategy has been to use the iPod to draw new customers --particularly users of PCs based on

Microsoft's

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Windowsoperating system -- to its Macintosh computers. As part of thatstrategy, the company on Tuesday

introduced a new cut-priced Macintosh --dubbed the Mac Mini -- targeted at potential "switchers."

Analysts have been divided on whether the iPod will draw in newMacintosh buyers. On the conference call, Oppenheimer noted that thisso-called halo effect is difficult to measure. But he noted that 40% ofrecent Mac buyers are either new to the platform or former Windowsusers. And the company's sales-growth rate last quarter was aboutdouble that of the PC industry as a whole, he said.

"That would suggest that we got some increased consideration," hesaid.

But the news wasn't all good from Apple. The company acknowledgedthat it is still facing supply constraints, a problem that has plaguedit in recent quarters. Those constraints are affecting both its iPodline and one member of its line of Power Mac computers.

Apple hopes to resolve the Power Mac issue,which involves the 2.5GHz G5 processor, by the end of its secondquarter, said Tim Cook, executive vice president of worldwide sales andoperations, on the conference call. Cook declined to say when thecompany would resolve its supply problems with the iPod, but suggestedthat it had more to do with demand for the device than actual supply,noting that the company's shipments were more than double the 2 millionunits it shipped in its fourth quarter.

"I don't want to get into supply and demand and where those meet,"Cook said, adding that "there is clearly not an assembly capacity issuewith the iPod."

Meanwhile, despite the overall increase in computer sales, thecompany saw a drop in sales of its PowerBook notebook line. Unit salesof the PowerBook line fell 22% year over year to 152,000 units, whilerevenue dropped 23% to $307 million.

But company officials stressed that they look at overall computersales, not the sales of any particular line. Sales of the company'slower-end iBook notebooks, which the company refreshed late last fall,appear to have replaced some of its PowerBook sales, they said.

In addition to Prudential, Bank of America also upgraded Apple'sshares following its report. Earnings forecasts and price targets wereraised at Merrill Lynch, CSFB, Fulcrum Global Partners and PiperJaffray.

Several firms noted the possibility that Apple's exploding iPodsales will translate into market-share gains in its personal computerbusiness. Bank of America, which raised its price target to $85 from$75, estimated that if Apple's PC unit could capture 3.5% of the iPod's2006 installed base, the segment's sales could jump 16%. The firmraised its 2005 earnings estimate to $1.87 from $1.64.