The day Apple landed in Gauna

March 17, 2011: 7:18 AM ET

Why did one of the world's fastest growing tech companies fall twice as fast as the market?

Boy. You leave town for one day and -- if you'll forgive an expression Elmore Leonard warns writers never to use -- all hell breaks loose.

Of course, with Japan's nuclear plants burning and the Dow dropping 242 points and change, you would expect Apple (AAPL) to take a hit. So some of its $15.42 drop Wednesday (on top of Tuesday's $8.13 loss) can be attributed to the rout that drove the whole market down.

But the Dow only fell 2.04% Wednesday. Apple's shares had their third worst day ever in dollar terms, falling 4.46% before the market closed and losing another 0.94% in after-hours trading. By the time the high-frequency traders had done their worst, a company whose revenues grew 70.5% last quarter was trading -- when you subtract out its massive cash holdings -- with a forward P/E ratio in single digits.

So forgive me if I place some of the blame for what happened Wednesday on an analyst named Alex Gauna at JMP Securities. I never thought much of Gauna's work -- his Q4 2010 predictions were among the worst of 38 Apple analysts Fortune surveyed (see here) -- but he really distinguished himself Wednesday by downgrading Apple and casting aspersions on its product sales even as customers were still (five days after launch) lining up outside Apple Stores in the early morning hours to buy the latest iPad.

Analysts with far better track records than Gauna felt obliged to shoot holes in his two chief arguments for downgrading the stock: 1) That Japanese supply lines are in turmoil and 2) that Hon Hai (Foxconn), which does much of Apple's assembly, has experienced a slowdown in what had been breakneck growth.

Oppenheimer's Yair Reiner pointed out Wednesday that Hon Hai -- which is dependent on other manufacturers for nearly 80% of its business -- is a lousy proxy for Apple. And Piper Jaffray's Gene Munster issued a note Thursday in which he addressed Japan's supply line troubles. While it's true that Toshiba (which makes 40% of the world's flash memory) and Mitsubishi (which is a major supplier of the resin used in iPhone and iPad circuit boards) have shut down their plants, Tim Cook buys these components in large pre-payment deals that guarantee supply and pricing. Apple is probably in better shape than any of its competitors to weather the storm.

But for me, nothing better underscored the shallowness of Gauna's analysis than the appearance Wednesday of a 100-page report on Apple by a team at Credit Suisse headed by Kulbinder Garcha. Under the headline "The Most Valuable Company in the World?" Credit Suisse set a $500 target -- $170 above Wednesday's closing price -- and summarized its findings with five bullet points:

  • Initiating with Outperform and $500 target price. We conclude that Apple should be able to deliver outsized revenue/ earnings growth of 50%/46% over the next two years, which is significantly ahead of consensus expectations (24% higher for FY12), given a sustained competitive advantage in software, hardware and services/apps ecosystem.
  • iPhone still the driver. Across the key smartphone success factors of software, services, product portfolio, distribution, brand, IPR, and chipset efficiency, we believe, three years after the launch of the iPhone, few competitors have managed to narrow Apple's advantage. This means within this fast-growth industry (smartphone unit growth of 52%/32% in 2011/2012), Apple's smartphone share should continue to rise to 20% in 2012 driving volumes of 72mn/112mn in FY11/12 with revenue of $47bn and $67bn.
  • iPad—addressing a $120bn market LT. Our proprietary analysis for tablets (takes into account factors such as regression analysis for long-term computing demand, pricing by tier, and cannibalization of multiple industries) highlights that the tablet market could rise to $120bn by 2015. Within this segment, we believe Apple will dominate, given aggressive pricing, time to market advantage and a software edge, maintaining share as high as 50% long term. This means that iPad should become a $34bn business by FY12. Further, our proprietary BOM analysis implies that GMs for this business will expand to 35% by end-FY11 from around the 27% levels seen in FY10.
  • Still room for an extra $10 in EPS. We believe that a low-end iPhone, greater push into emerging markets, and enterprise traction could add $10 of EPS. Even beyond this, we see scope for Apple to leverage its ecosystem and its current installed base of 200mn (rising to 700mn over coming years) with revenue from advertising, broadcasting or perhaps the TV business.
  • Valuation. We arrive at our $500 target price using a combination of P/E, DCF, and HOLTTM analyses. On our CY12 estimate, Apple trades on a P/E multiple (ex-cash) of 8.9x, which we believe is inexpensive, given the potential for earnings growth of 46% over the next two years.

That, Mr. Gauna, is how real analysts do it.

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About This Author
Philip Elmer-Dewitt
Philip Elmer-DeWitt
Editor, Apple 2.0, Fortune

Philip Elmer-DeWitt has been following Apple since 1982, first for Time Magazine, and now on the Web for Fortune.com.

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