Apple: Buy on the dips

It's the world's coolest tech company, a colossal cash cow and the largest listed business on earth, but Apple has just disappointed Wall Street. Despite generating higher sales and bigger profits than expected during its third quarter, the share price plunged by as much as 9% in after-hours trade Tuesday, just because it sold fewer iPhones than predicted. That's harsh, and substantial support has kicked in at $119-$120 (see chart below). Investors write Apple off at their peril.

Last night's sell-off wiped a mind-boggling $67 billion off Apple's market value. Having closed down slightly at $130.75, the price touched $119.20 once results were published after the market close. That's a few cents less than the five-month low registered just a fortnight ago.

But this, if anything, looks like a healthy correction. There really is little wrong with the numbers. In only three months, Apple generated revenue of $49.6 billion and earnings per share of $1.85, up a 33% and 45%, respectively from last year.

"We had an amazing quarter, with iPhone revenue up 59% over last year, strong sales of Mac, all-time record revenue from services, driven by the App Store, and a great start for Apple Watch," said chief executive Tim Cook. Look for revenue of $49-51 billion in the fourth quarter and gross margin of 38.5-39.5%.

Source: TradingView (click to enlarge)

An incredible 47.5 million iPhones were sold worldwide in the three months to 27 June, generating $31.4 billion of revenue. That gives an average price of $660, up from $561 a year ago. But while Apple beat Wall Street estimates on most other metrics, analysts had predicted Apple would sell as many as 52 million iPhones during the period (consensus was 48 million).

While that's not a catastrophe, Keith Bachman at BMO Capital Markets predicted the negative reaction. "The stock will need to retreat some in the near-term despite the Apple story remaining compelling," he said. Questions are being asked about Apple Watch, too. Although actual numbers were not disclosed, initial shipments are said to have met the company's own expectations. But that's thought to mean 2-2.5 million units during the quarter, less than the 3.5-4 million pencilled in by analysts. Still, it is early days and BMO projects 27 million Watches will be sold in 2016.

Despite a few weak points, Bachman has raised earnings per share forecasts for the year ending September to $9.14 from $9.01, and to $9.83 from $9.75 for 2016.

He still rates Apple shares as 'outperform' and sticks with a $145 price target. "Our target price is based on a P/E of 14-15x and EV/FCF [free cash flow] of 9x-10x our FY16 estimates," says Bachman. "We believe the growth of iPhones will largely determine the opportunities for AAPL shares."

Since breaking out above $120 in February, shortly after record first-quarter results, Apple shares have tracked the wider market sideways in a tight $13 range. But sell-offs tend to be brief affairs and are typically treated as buying opportunities.

Billionaire hedge fund manager and large Apple shareholder Carl Icahn has certainly been talking up his own book this year. Apple shares will eventually hit $200, he says. It would be hard to disagree.