The best definition I have ever read of a value trap comes from Investopedia. Investopedia defines a value trap as “a stock that appears to be cheap because the stock has been trading at low multiples of earnings, cash flow or book value for an extended time.”
One of the greatest challenges in investing in Apple Inc. (NASDAQ:AAPL) is that the stock trades at a low valuation, but the price doesn’t reflect the attractiveness of the company. The stock fell by 41.96% from its 52-week high. The decline in valuation was driven by falling margins from its Apple Inc. (NASDAQ:AAPL) iPad Mini paired with the lateness of a product refresh cycle, and a lack of growth in emerging markets.
Apple stock could fall lower
Over at Seeking Alpha, author Brennan Basnicki makes some solid points to sell Apple Inc. (NASDAQ:AAPL), which I will try to summarize with three bullet points.
Low price-to-earnings multiples may not necessarily be a good thing.
Do not buy a stock that is trading below the 200-day moving average.
Avoid stocks that report a decline in earnings growth.
Basnicki repeatedly points to basic principles that have worked for Mark Minervini throughout his trading career and points out that these indicators could be negative for Apple’s stock price.
Let’s start with valuation and growth
At the time of writing, Apple Inc. (NASDAQ:AAPL) trades at a 9.5 price-to-earnings multiple. The prevailing argument is that Apple’s stock is a value trap (looks cheap now but may have even further downside).
However, let’s look at a different indicator because the price-to-earnings multiple doesn’t necessarily tell us nearly enough about the company. The tech sector is known to pay ridiculous premiums for the amount of growth in earnings. The technology sector has a 3.4 price-to-earnings-growth (PEG) ratio on average. In comparison, Apple Inc. (NASDAQ:AAPL) sells at a 0.5 PEG.
The stock is inexpensive based on its PEG ratio. Growth is the most important indicator, and so as long as that stays intact, there’s no reason to think that the stock is a value trap. Sure, it may not generate 70% year-over-year earnings growth, but even back then, the stock never traded at a really high earnings multiple relative to earnings growth.
So to say that a stock is reporting a sequential decline in year-over-year growth, and stating that could be a potential reason for why the stock should be cheap, I could understand that argument. However, the stock seems to be on track. This is based on the 20.88% compounded earnings growth that analysts have projected over the next five years.
I believe it is impractical to expect a decline in demand when considering all of the opportunities to sell Apple Inc. (NASDAQ:AAPL) devices internationally. Apple’s management team has a poor track record of providing guidance. Usually, what happens is that the team points out some reasons for why earnings could miss, and then subsequently report some awkwardly large number. The company’s product portfolio is certainly superior to its competition, and it has a stickier ecosystem than Research In Motion Ltd (NASDAQ:BBRY) and Google Inc (NASDAQ:GOOG).
The 200-day moving average
Source: FreeStockCharts and Alex Cho
Google Inc (NASDAQ:GOOG) fell below its 200-day moving average at one point, before rallying by 50%. Over-generalizations like a stock shouldn’t be bought below the 200-day moving average should be ignored. A good company should be bought regardless of what the trailing price average has been over the past 200 days. The performance of a company is not reflected in its stock price. While it is true that sentiment moves the value of a stock, it is not a representation of its true intrinsic value.