by , 10:15 AM EDT, September 29th, 2005

Merrill Lynch lowered its rating on Apple's stock from "Buy" to "Neutral," according to a research note obtained by The Mac Observer. While acknowledging Apple's "extraordinary" execution, Analyst Richard Farmer cited concerns that future upside for the stock was limited, mainly because continued growth in iPod sales appears to have already been built into the stock's value.

Specifically, the firm believes that Apple can continue to gain market share in the digital media device market, but that current valuation already includes an expected 35-40% penetration into the consumer PC installed base by 2007.

While that expectation is reasonable, according to the firm, Apple is unlikely to dramatically exceed that rate, which limits further stock growth. In other words, Merrill Lynch believes that future iPod gains are already priced into the stock, and that it is unlikely Apple will be able to grow beyond those gains already expected by the market.

Accordingly, the firm said that fair value for Apple based on fiscal 2007 earnings is between US$50 and $60 per share. In Thursday trading, AAPL is trading at $51.57 per share, up 0.49 (+0.96%).

Merrill Lynch also cited other areas that could pose challenges to Apple, including the transition to Intel, which "could cause customers to pause, offsetting the [iPod Halo Effect];" competition from Microsoft's Vista Windows operating system, which "could hold back Mac share gains in 2007;" and the fact that it's hard to improve on the company's outlook "when everyone [already] knows everything is going right for a company."

The firm noted that iPod Halo Effect is material, but "difficult to separate from the independent effect of PC product cycles." That means that the company finds it difficult to quantify exactly how much the iPod Halo Effect benefits Mac sales.

Lastly, the research report said that the Motorola ROKR phone will have "limited success," though future iteration of iTunes phones might have a material impact on Apple. In light of that, none of the financial models developed for the firm's analysis include ROKR contributions to Apple.

*In the interest of full disclosure, the author holds a small share in AAPL stock that was not an influence in the creation of this article.