Apple 2.0

Covering the business that Steve Jobs built

Why AAPL has been in the doldrums for the past 6 months

June 14, 2011: 11:02 AM ET

Exploring the mysteries of what the analysts call "multiple compression"

When Apple's (AAPL) shares responded to the news out of the company's developers conference by closing the week at $325.90 -- their lowest level since last December -- I thought I'd take a look at how last Friday's stock price compared with the 12-month price targets Wall Street's analysts posted exactly one year earlier, after the conference that introduced the iPhone 4.

I dug out a dozen analyst's reports issued on June 7 and 8, 2010, expecting to find numbers that were wildly off the mark. To my surprise, the 12-month price targets neatly bracketed the stock's current price. They ranged from a low of $287 to a high of $350, with a mean of $322.33 -- just a few dollars off Friday's close.

Where the analysts seem to have gone off the rails last year is in the price-to-earnings multiples on which they based their predictions. To calculate their price targets, they multiplied Apple's estimated earnings by factors that ranged from 16 to 22.5. When Apple more than delivered on those estimates -- growing earnings 74.6%, 67.5%, 75.2% and 92.2%, respectively, over the next four quarters -- two things happened: 1) the run on Apple's stock price came to a halt, and 2) the analysts cut their multiples.

When we asked these 12 analysts to explain the discrepancy, the four who responded all gave the same answer: "multiple compression."

Take, for example, RBC's Mike Abramsky. His 12-month price target for Apple in June 2010 was $350, based on 22 times Apple's estimated fiscal 2011 earnings. His current 12-month target is $450, based on 11 times earnings.

"Last year investors were excited about Apple's massive tablet head start and iPhone share gains/market expansion (e.g. the Verizon iPhone)," he wrote by way of explanation. "This year, the multiple has been compressed by the market. Investors appear more restrained than last year, considering the big run in the stock. It reflects market uncertainty regarding what will drive the next leg of growth, how much or not Android will impact Apple, Steve's health, etc. Another reason for the lower multiple is higher cash.  It is currently 20% of the stock price vs. 17% 1 year ago."

Susquehanna's Jeff Fidacaro attributed the sharply reduced multiples to the Street's belief that Apple's quarters of breakneck growth are largely over.

"My sense is 1) given Apple's success in iPhone and iPad and the law of large numbers, consensus is modeling about a 16-17% revenue growth in FY12 from over 60% in FY11 and 52% in FY10, significant deceleration; 2) investors less willing to give Apple credit for its massive net cash balance; and 3) investor concerns on Steve Jobs's health."

BCG Partner's Collin Gillis notes that the broader market has also been compressed over the past six months -- by his calculation from 15x to 13.8x -- but that Apple is getting squeezed more than most. Reason: Apple's most recent quarter "was about as good as it gets."

"A year ago, the iPad was a new source of revenue for Apple," says Gillis. "Growth over zero was tremendous. Now it's not, and revenue growth has to slow down. The stock can still go up, but waiting for a multiple to decompress is like waiting for grass to grow."

For the record, the current 12-month price targets for Apple, as reported by Thomson/First Call, range from a low of $210 to a high of $612, with a median target of $450.

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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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