Relax, Apple Isn't Broken

Yesterday, Samsung Electronics reported a record $8.28  billion profit, where it sold nearly 62 million smartphones in the fourth quarter (even with the debut of the iPhone 5). So where does that leave America’s darling Apple? Forget the talking heads for a second, the world is large enough for two titans. Even though I believe iPhone 5 earnings estimates are a little high, Apple is still a buy around these levels.
 
The Technicals:

Since the start of the fourth quarter, Apple’s stock has been a train-wreck. First it created a Negative Divergence, then it looked like Apple was creating a massive Head and Shoulders pattern and finally it triggered a Death Cross (a ridiculous late pattern). However, there are some positive technicals that a bull like me can look forward to:

 

The recent rally (and pullback) finally confirmed that Apple is in a downtrend (yellow line). Furthermore, it’s established major support around $505, creating what could be a descending triangle (after each bounce from support, Apple has created lower highs). While this is usually a bearish pattern, because the downtrend resistance (yellow) line is falling at such a fast rate (about $2.10 per day), the result of a break would theoretically not be as severe as a break of a more horizontal descending line (the more horizontal a downtrend line is, the harsher the break in a descending triangle). Volume seems to be confirming the descending triangle pattern (overall it’s contracting as days go by), so keep an eye on any expansion of volume when either the resistance or support is broken.

Another possible bullish pattern that is developing is a positive divergence. This happens when the price of a security makes a lower low while its main indicator makes a higher low. While it is not the most credible technical pattern, Apple did create a negative divergence (exact opposite of a positive divergence) back in August-October when it made a higher high in price, but a lower high on the MACD (a 30% sell-off followed afterwards). Watch the MACD resistance (labeled white line) for confirmation of this pattern.

Lastly and probably the most important technical pattern on Apple’s chart, is its multi-year upward sloping channel. Apple hasn’t broken through the bottom (support) trendline since the Recession! A break would officially mark Apple as a broken stock.

 

Apple’s MACD is telling a story. Earlier this year, it was screaming overbought when it nearly went vertical at the beginning of 2012. After the euphoria simmered down, its MACD made a lower high, while Apple made a higher high (another negative divergence). Since then, it has fallen through zero (cut through it like butter) and has fallen to Recession level support (last seen in late 2008 after Lehman Brothers failed). If it can reverse at these levels, the next resistance sits at zero, which would signal a shift in momentum following an upside break (this is a delayed signal).

 

A Change in Strategy is Needed:

Although Samsung’s Galaxy lineup has clearly dethroned Apple’s dominance, this does not signify that Apple’s story is ending. Apple still has many markets to penetrate, which should scare RIM and Nokia should it choose to build a lower end device for emerging markets. As Jessica Lessin from the WSJ explains: “while Apple has explored such a device for years, the plan is progressing and a less expensive version of its flagship device could launch later this year.” Even though this shift in strategy would obviously lower Apple’s margins, investors have known for years that Apple’s margins would eventually peak and later contract. If Apple hopes to emulate Samsung’s success, it needs a cheaper device (similar to the iPad mini which is a huge hit in China) to compete for consumers who cannot afford their premium priced devices.

 
Conclusion:

Did everyone suddenly forget that Apple has rallied over 800%? A 30% pullback is normal and considered healthy! Apple isn’t a broken stock, far from it actually. Putting the technicals aside, you’re buying a 9.1 forward P/E stock, with at least 10% annual growth over the next 3 years (not including any new innovative product launch). You’re buying a stock that’s cheaper than Intel, that has over $120 billion in cash, a 2% dividend, and a company that has yet to penetrate a number of growing markets (with growing incomes). The point is to grab a customer early and hope that eventually they’ll integrate into the iEcosystem with other products.

Apple only trades at a 9.1 forward 12 month P/E while the overall technology sector has a 12.5 forward 12 month P/E.
 

Will Apple ever reach $1000? I highly doubt it. But that doesn’t mean it can’t go back to $650 (a 24% gain) or $700 (a 33% gain). Unless Apple totally blows it, from where I’m sitting, the risk/reward is just too juicy to not get behind this stock.

 
 

Questions? Comments? Leave me a reply