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Apple (NASDAQ:AAPL) stock is on the move again. The stock leapt $40 per share on Friday — a chunky 10% move — following the company’s much stronger than expected earnings report. On Monday, it added to gains and notched a fresh all-time high of $446 per share. Give the company credit, it shrugged off the novel coronavirus and managed to deliver stellar numbers.
It appears that all the pandemic relief payments really aided the company; the enhanced unemployment benefits and $1,200 checks gave a lot of folks disposable cash with which to buy Apple products. In addition to the earnings shocker, the company served up another surprise: It will be splitting shares four for one. This means that one $440 share will turn into four $110 shares of Apple stock.
Enthusiasm for the stock split certainly helped ramp Apple shares over the past week. And justifiably so, stocks often perform well going into splits. However, traders should consider booking gains soon — AAPL’s valuation is becoming stretched at current levels.
For one thing, however, many investors don’t have access to fractional trading. And many traders perceive higher stock prices as being more expensive. A $100 share is viewed as more accessible than a $400 one, even if the company has the same underlying market capitalization in both examples.
Additionally, there’s one huge difference between Apple and the other three companies I named. Apple is an upstanding member of the Dow Jones Industrial Average. The Dow is price-weighted, meaning that the gauge moves based on how many points a company’s stock trades for. This makes high-priced stocks like Apple and Boeing (NYSE:BA) extremely powerful. Meanwhile, a stock trading for, say, $40 has almost no influence on the DJIA average.
As of this writing, Apple stock constitutes 10% of the entire Dow Jones index and related exchange-traded funds (ETF) products. The next largest holding is UnitedHealth (NYSE:UNH). UnitedHealth trades at $300 per share — significantly less than Apple — and thus constitutes less than 8% of the Dow Jones index. This stock split will get Apple down to a more reasonable portion of the Dow and keep it from unbalancing the overall index.
The stock split is an exciting bit of news. And getting the share price down to a more manageable level could broaden the shareholder base. However, it won’t solve the company’s main problem: It’s already too big.
There’s no real trend here. Apple’s net income has wandered around the $50 billion mark in recent years and peaked back in 2018. And let’s give Apple credit for a moment. It’s a mighty impressive feat to earn $50 billion each and every year. However, the company’s growth is clearly stalled out.
Yet, over this same span, while meaningful growth in net income has stopped, the stock price has gone exponential. Shares are up almost four-fold even as profit growth has nearly ceased. So how are shares soaring? Two factors. One, the price-earnings ratio has more than triple, from 10x in 2016 to 33x earnings now. And two, Apple is buying back stock.
Apple can’t rely on a rising P/E for much further growth. Realistically, how far do you think that multiple is going to go? 40x? 50x? There is a limit — and it’s not far off — for a company that can’t grow net income quickly. As for the buyback, you can retire a lot of shares when your stock is trading at 10x earnings. However, at 33x earnings, even if Apple spends 100% of its annual profits on the buyback, it will only increase earnings by 3% a year — not enough to move the needle.
There simply aren’t many paths to reasonable stock returns for Apple going forward. Investors need to honestly ask themselves what they are expecting here. The stock is up fourfold over the past five years even as the business has nearly stopped growing.
Apple hasn’t introduced many revolutionary new products since Steve Jobs died. The P/E ratio is already up to nosebleed levels. The company’s market capitalization is approaching 10% of total U.S. GDP. What more are you waiting for? Take advantage of extreme sentiment to lock in profits.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek. At the time of this writing, he held no positions in any of the aforementioned securities.
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