We might be barely two months into 2013, but the market has already rallied by 7% since the start of the New Year. Gains in the market come in spite of anemic earnings growth. Companies are still reporting results for the final quarter of 2012, but it looks like earnings growth should clock in at less than 1% across 2012. That means companies’ share prices are soaring with little earnings growth and P/E multiples are getting bigger.
The situation must seem befuddling to Apple Inc. (NASDAQ:AAPL) investors. The company’s earnings grew 27% throughout 2012, yet its stock slide has seen its P/E shrivel all the way down to slightly north of 10 times earnings. That compares to the S&P 500’s P/E ratio that’s closer to 17.
Why is Apple Inc. (NASDAQ:AAPL) trading so cheaply in a market full of companies with little to no growth that trade at much richer multiples? Let’s take a dive into Apple’s cheapness and what it says about the tech market itself.
Kohl’s, Safeway, and… Apple?
The chart below stacks up Apple Inc. (NASDAQ:AAPL)’s cheapness relative to some tech peers. On a P/E ratio basis, it now trades in the same league as Kohl’s Corporation (NYSE:KSS) and Safeway Inc. (NYSE:SWY), companies in highly competitive markets with a recent track record of little growth.
Overall, the most startling perspective is Apple Inc. (NASDAQ:AAPL) trading at a P/E ratio that’s in the bottom 10% of the market. A company’s P/E ratio is in large part a reflection of what investors feel its growth opportunities are moving forward. Is Apple’s growth in the years ahead really worse than 90% of companies?
A crowded market
The most common cause for concern around Apple Inc. (NASDAQ:AAPL) isn’t that the company won’t remain a dominant player in technology. Instead, worries seem to focus on two main areas:
1). Can the company keep finding new areas of growth? Investors might be used to seeing eye-popping growth rates for smartphones, but the nature of smartphone growth is changing. Last quarter, 89% of phone sales to contract subscribers on AT&T Inc. (NYSE:T) were smartphones. Simply put, in developed markets such as America and Europe with a robust market for high-end phones, most users already have smartphones. That means future growth rates are shifting to areas such as China and India, where low-end phones will be more popular.
2). Can it keep its margins up? Apple’s margins slid from 47.4% last March down to 38.6% last quarter. Competition in areas such as tablets has been mainly on the low end, attacking pricing differences with Apple.
To be sure, concerns about Apple’s sheer size are very real. A study out yesterday from researcher NPD showed that the company now commands 20% of consumer technology sales revenues in the U.S.That’s more than double the next highest company, Samsung.
However, what many investors seem to overlook is that Apple’s sell-off isn’t just about Apple itself — it’s about uncertainty over the smartphone industry itself. Apple’s chief rival in the space has become Samsung, which shipped 216 million smartphones last year, significantly ahead of Apple’s second-place finish of 136 million smartphones shipped. Samsung has become the dominant Android company and left Apple’s growth rates in the dust last year. The company grew earnings by 74% in 2012, significantly ahead of Apple’s 27% growth rate.
Yet Samsung itself trades for just 8.5 times earnings, a significant discount to Apple’s already rock-bottom P/E ratio. If Samsung were in the S&P 500, only 18 companies would have a cheaper P/E ratio than the company. Another large smartphone play, HTC, finds itself at 8.8 times earnings.