How Much Lower Could Apple Inc. (AAPL) Go?

Amazon’s Kindle Fire came in second to the iPad with a considerable 7.7% of web traffic share. Though Kindle unit sales are unknown due to Amazon’s silence on the matter, the company stated that “at year-end, Kindle Fire HD, Kindle Fire, Kindle Paperwhite and Kindle held the top four spots on the Amazon worldwide best seller charts since launch.”

With 56% of Apple Inc. (AAPL)’s revenue coming from one product, the risks associated with Apple Inc. (AAPL)’s business model are high. Though Apple does have a nearly flawless history of successful product launches over the last 10 years, it’s still risky to assume the same will be true for the next five years — especially as competition heats up.

As far as profitability, Apple Inc. (AAPL)’s declining gross margin, from 44.7% in the year-ago quarter to 38.6% today, has investors worried that competition is beginning to put pricing pressure on Apple’s products.

The result is Apple’s current P/E of just 9.5.

A positive twist
Though Apple Inc. (AAPL) is definitely facing some headwinds, a positive twist on the same three factors reveals quite a different picture.

For instance, Apple Inc. (AAPL) may be losing market share to Samsung, but the smartphone and tablet market as a whole is still growing rapidly. A report from ABI research predicts an annual industry growth rate in smartphones and tablets of 44% and 125%, respectively.

And yes, Apple Inc. (AAPL)’s gross margins may be declining, but the company’s pricing power is still the envy of the industry. In 2012, Apple Inc. (AAPL) managed to convert $0.28 of every dollar of sales into free cash flow.

An irrational valuation
A reverse discounted cash flow valuation, using an 11% discount rate, reveals that the market assumes a 3.3% growth rate in Apple Inc. (AAPL)’s free cash flow at today’s price. This means that investors expect Apple to only keep up with the historical rate of inflation going forward.

The negative factors surrounding Apple Inc. (AAPL) undoubtedly have an outsized influence on today’s market price. Even if Apple’s sales were flat in 2013, it could significantly boost EPS by buying back shares more aggressively with some of its massive cash hoard of more than $100 billion. In fact, yesterday Warren Buffett publicly encouraged Apple to do exactly this.

Headwinds are priced into Apple’s stock. But the rapidly growing smartphone and tablet market is not. Though it’s hard to estimate exactly where the bottom is for Apple Inc. (AAPL)’s shares, there is no doubt we are getting close. The market will always have shortsighted and unpredictable doubts, but the patient investor can take advantage of this significant sell-off to load up on more Apple Inc. (AAPL) shares.

As Buffett says, “Be fearful when others are greedy, and greedy when others are fearful.”

The article How Much Lower Could Apple Go? originally appeared on Fool.com and is written by Daniel Sparks.

Fool contributor Daniel Sparks has no position in any stocks mentioned. The Motley Fool recommends Amazon.com, Apple, and Google. The Motley Fool owns shares of Amazon.com, Apple, and Google.

Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.