This column originally appeared on Real Money Pro at 9:55 a.m. EDT on May 23.NEW YORK ( Real Money) -- My next long purchase will be Apple ( AAPL), as the risk/reward ratio begins to move into positive territory. While Apple remains a trading sardine not an eating (or investing) sardine, in my view, over the next six to 12 months, downside is $400 to $410 a share and upside is likely $500 to $525 a share -- though depending on the timing and context of new product release, this could be higher. While still elevated vis-a-vis my expectations, consensus sales and earnings expectations have been reduced dramatically and have now grown more realistic. Instigated by Greenlight Capital, the company has embarked upon an aggressive return of capital to shareholders. While it is generally recognized now that Apple's profits will be relatively stable and show little growth over the next two to three years (likely between $35 and $45 a share), free cash flow generation will be meaningful and will support continued buybacks and dividend increases. Investor sentiment could hardly be worse, as the company's shares have gone from hero to goat. The offshore tax issue has likely come and gone after this week's testimony. (I give Tim Cook a split decision win over the Congressional questioners.) Below is what I wrote in my surprise list for 2013 back in early January -- at the time, mine was a variant view. That said, my surprise has generally been realized.
Surprise No. 8: Apple's share price and earnings continue to disappoint in the first half of 2013.(Note: At around 10:57 a.m. EDT, Doug Kass bought Apple shares at $443.65.)
Last year, I wrote that Apple would be a positive surprise in 2012, though I turned negative on the company's fundamentals and share price in late September. This year I have a negative surprise in store for Apple -- at least for the first half of the year. The aforementioned Senator Levin subcommittee investigations on offshore tax havens (see surprise No. 1) highlight Apple's tax avoidance strategies. The share price drops below $500 a share in first quarter 2013, as investors begin to recognize that it is likely that Apple's future earnings will be taxed at a much higher rate than in the past. Meanwhile, Apple's core operating profits disappoint due to a more competitive landscape, lessening demand for iPads and iPhones and emerging margin pressures. Apple's earnings estimates (and price targets) are cut, and full-year 2013 results fall short of $40 a share. Microsoft's (MSFT) Surface sales start off poorly but gain traction by the end of 2013. Google (GOOG) Nexus, Amazon (AMZN) Kindle, Surface and Samsung all sell at lower price points throughout the year, as price competition emerges in the tablet market. Apple's consensus 2014 profit estimates move toward an expected year-over-year decline. The stock spends most of 2013 below $550 a share, but, in the last half of the year, two revolutionary product additions lift the share price to over $600 by year-end. (Samsung's stock performance continues to outpace that of Apple in all of 2013.) In the third quarter Apple announces three new products in 2013: iTV, iMed and iHomes. iTV is a yawner, but the latter two are revolutionary product additions. With iMed, Apple enters the medical information market, providing a platform for the medical field to keep, store and transfer records in real time. This expands the use of iPads exponentially. Also introduced is the iHomes program, an iTunes-like software to control all electrical (and some non-electrical, like plumbing) elements in a home remotely. The software receives rave reviews from The Wall Street Journal's Walt Mossberg, after which Apple announces it will not license the software for use on Android devices. (Google shares drop 60 points on the announcement.)
- A consistently low share price for Apple persists in the first half as earnings estimates are steadily reduced, owing to lower production rates.
- Tech stocks (in general) and Apple's stock (in particular) sell off after Senator Levin's subcommittee finds that companies have avoided huge amounts of U.S. taxes in offshore tax havens.
- Two important product releases lead to an improving share price for Apple in the second half.