Nov 172012

One extreme begets another.  From one extreme to the other.  For every action, there’s an equal an opposite reaction.  Whatever you want to call it, that’s what we’re experiencing with AAPL this year.  The Valuation Range Chart now shows a rather large valuation range for this year.  From a P/E high of 18.3 in April to a P/E low of 11.5 this week, only seven months later.  By that measure we just had a 37% correction in AAPL valuation.  But that’s really not a fair metric.  I prefer my Continuous Valuation (CPE) metric.  But even when measuring using CPE, we just had a 30% valuation correction in only 2 months.  We went from a CPE peak not seen in over a year, to a CPE level not seen in over 3 years, not since early 2009 near the depths of the financial crisis.  See my new CPE Range Chart to see how CPE has changed over the past few years.  So why did we get these extremes this year?  Is there an explanation for this that makes sense?  Yes, there is.

The very strong rally in early 2012 was due to the strong 95% TTM earnings growth during FY12 Q1 and Q2.  With such steep CPE lines, price had to move up very rapidly to keep up with Apple’s valuation.  That rally created some huge momentum.  Because of the way crowd psychology works, that momentum snowballed and fed on itself, and AAPL moved to an unnaturally high valuation level.  Before that period, AAPL had been in a period of P/E compression as it grew in size to become the largest company in the world.  So for three quarters, AAPL deviated from that P/E compression and instead experienced P/E expansion, and CPE expansion too (my preferred valuation metric instead of P/E).

But that period is over.  Earnings growth is coming back to earth now.  The earnings comparison for the upcoming FY’13 Q1 and Q2 will be tough compared to 2012.  Trailing 12 month growth is already back down to 60%, and will very likely move even lower for the next two quarters.  And so here we are.  Valuation compression is reasserting itself.  And it’s doing it in dramatic fashion in one swift 8 week move. AAPL is probing to find a new valuation low level.  Did it find that lower valuation level this week?  I claim that yes, it did.  And we need to proceed assuming that the price low is in.  CPE dropped to a low of 11.4 this week.  That’s down firmly in the range of the valuation AAPL had at the depths of the financial crisis in 2009.  Could I be wrong assuming the price low is in?  Yes.  But if I’m wrong, I’m virtually certain I’m not wrong by much.  Downward momentum on the latest thrust lower is lower than the down thrust before it.  Price moved down less this time, and had a more powerful move off the lows in less time than before, on even higher volume.  The evidence is convincing, and the probability is rather high.

AAPL did drop to a lower CPE level this quarter than I expected, however.  It is likely another story of extreme momentum and sentiment making AAPL go farther that it otherwise would have.  I didn’t even expect AAPL would hit the CPE 11.8 level from last 2011, let alone drop below it.  But let’s look briefly at what happened this week.  We dropped below the CPE 11.8 level intraday, but closed back above it.  That means, for one day at least so far, a valuation below 11.8 has been rejected.  I’ve left the CPE 11.8 level line on the Valuation Range Chart.  So far we haven’t closed below that level, we only dropped below it intraday.  As long as we get follow though on Monday, and don’t close back below CPE 11.8, that level can remain an important valuation level to track as we move forward.  Nevertheless, AAPL did trade down to CPE 11.4 intraday, so there has been at least some acceptance of that level that hasn’t been seen before.

Back to the longer term valuation trends.  The 3 quarter valuation expansion generated valuation levels that AAPL is unlikely to see again.  In other words, I do not expect to see CPE 16.2 reached in 2013.  The next valuation swing high, which is expected during the first part of 2013, will likely fall short of the CPE 16.2 line drawn on the Valuation Range Chart.  How far short?  I don’t have an opinion on that.  Not yet.  We need more information.  I want to see how much pressure AAPL valuation remains under for the rest of 2012 and the rest of the earnings quarter (until the next earnings release in January).  Once we see that, we can make a determination about what to expect for the next sustained rally to the next valuation swing high.