Morningstar Growthinvestor Explains ‘Why the Market is Wrong on Apple’

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Financial research firm Morningstar takes a look at Appleis stock in the latest edition of its Growthinvestor newsletter. The company currently has a fair value estimate of US$29 per share, which writer Mike Trigg explains "assumes 25% annual revenue growth over the next five years."

He continues: "We expect significant iPod growth this year and next, with sales declining thereafter due to lower prices and increased competition. In our view, iPod revenues will eventually decline as alternative music players emerge and the early-adoption phase comes to an end.

"At the same time," he writes, "we think the iPod will drive increased adoption of Apple computers, resulting in the firmis PC market share (1.8% in 2004) expanding to more than 3% in a few years. That implies Apple will go from selling 3 million units to 6-9 million units annually."

Despite such rosy predictions, however, Mr. Trigg says that to view Appleis current $42 per share price as fair, "we must make several optimistic assumptions. The first is that Apple will maintain iPod growth and suffer little pricing pressure as it rolls out new iPod features such as wireless and video. This would result in iPod sales doubling to roughly 40 million annual units five years from now. Also, we must assume that iPod sales will lead to greater Mac adoption than we currently expect, allowing Apple to double its PC market share to 4%. Finally, there will be significant leverage in the business, and operating margins will expand from the high single digits to the mid-teens."

He notes that Appleis future "boils down to whether or not the company can continue growing iPod sales over the next five years, which would be one of the most remarkable achievements in the history of consumer electronics. After all, theyire all toasters in the end!" Because Morningstar believes iPod sales will eventually slow down, Mr. Trigg says that his company will pass on Apple at its current share price.

As of 2:00 PM EST on Monday, Appleis stock stodd at $42.91, down 0.19% for the day. Shares were up in early trading, but both the Nasdaq and the Dow headed into negative territory in the afternoon, after oil prices set a new high per barrel.

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