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Technology > Tech Biz
Apple blossoms
Shares of the iPod maker have held up well during a turbulent market. And there's more room to grow.
August 25, 2004: 12:11 PM EDT
By Paul R. La Monica, CNN/Money senior writer

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NEW YORK (CNN/Money) - You've heard of the Teflon Don and the Teflon president. Apple Computer is the Teflon tech stock.

There is a rather lengthy laundry list of concerns facing the company. So considering how jittery the market has been for the past few months, it's truly amazing how well shares of Apple have held up.

Here are just a few of the issues the Mac faithful have had to ponder:

CEO Steve Jobs' cancer surgery, intensified online music competition from Real Networks and Roxio (which is renaming itself Napster), rumblings about an imminent online music entry by Microsoft, Sony's debut in the digital music player market, delays in the introduction of the new iMac, concerns about a shortage of the G5 processor and a recall of some PowerBook batteries.


Despite all this, Apple's stock is up more than 45 percent this year. Since my last positive column about Apple in mid-May, the stock is up 16 percent. Meanwhile the Nasdaq lost 2 percent. Even during the tech sector's summer collapse (since the end of June), Apple shares are off just 4 percent, while the Nasdaq has fallen more than 10 percent.

Guess what: I still think Apple (AAPL: Research, Estimates) looks attractive. Here's why.

Don't sweat short-term supply shortages

The biggest issues facing Apple in the short term are various component troubles. The iPod mini is currently on backorder, for example, because of hard drive shortages at supplier Hitachi.

What slump? Apple has been a strong performer in a rotten market for tech stocks.  
What slump? Apple has been a strong performer in a rotten market for tech stocks.

The G5 shortage is worrisome because it could not only affect the roll out of the new iMac (although there are rumors that Apple will debut it at next week's Apple Expo in Paris and start selling it in September). These shortages could also put a crimp in sales of PowerMacs. IBM makes the G5.

But at least customers are showing a healthy interest in Apple's products. At a time when the market is fretting about the possibility of a consumer and corporate spending slowdown, investors can at least take solace in the fact that Apple probably isn't facing a looming inventory glut.

"It isn't a demand issue," said Bill Fearnley, Jr., an analyst with FTN Midwest Research. "There will be some turbulence near-term based purely on component delivery issues that are beyond Apple's control."

For this reason, Fearnley, Jr. recently trimmed his earnings estimates for Apple's fiscal fourth quarter (which ends in September) but raised his estimates for all of fiscal 2005, citing the strong appetite for Apple's products.

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That's been the story for Apple all year. Earnings estimates have steadily climbed, justifying the move in the stock. In January, analysts were predicting earnings of 59 cents a share for fiscal 2005, according to Thomson First Call. The consensus estimate is now 89 cents a share, an increase of more than 50 percent.

"The stock price has been driven by fundamental improvement in Apple's numbers. It's not just speculation. As long as the numbers keep getting better, the stock is not very expensive at all," said Robert Cihra, an analyst with Fulcrum Global Partners.

Apple trades at about 35 times earnings estimates, which doesn't exactly appear thrifty at first blush. But the company continues to sit on a large sum of cash, about $5 billion. If you factor that out, Apple's fundamental business is trading at a more sensible P/E of 21.

Music and Macs on growth track

Still, what about all those other concerns, especially the increasing competition in music? They have to be taken seriously since the iPod and Apple's music store iTunes are becoming an increasingly important component of the firm's overall growth story.

What a difference a year makes
Music is now a major contributor to Apple's overall sales.
Product % of 3Q '04 sales % of 3Q '03 sales 
iMac 12% 20% 
iBook 13% 13% 
Power Mac 16% 15% 
PowerBook 22% 23% 
iPod and other music 16% 8% 
Peripherals 11% 11% 
Software 10% 10% 
 Source:  Apple Computer

In its fiscal third quarter, which ended in June, 16 percent of Apple's total sales came from music-related products, up from just 8 percent a year ago. According to Lehman Brothers analyst Harry Blount, nearly a quarter of Apple's sales for fiscal 2005 could be from the iPod and iTunes.

So far, Apple has held off challenges from its numerous competitors. Will it be able to do the same when Microsoft enters the fray? Blount is optimistic that Apple has learned from past strategic errors.

Namely, he thinks that Apple's partnership with Hewlett-Packard, the world's second-largest maker of personal computers, is a good sign. HP will be launching its own branded version of the iPod later this year and Blount thinks this deal shows that Apple is wisely seeking help in order to fend off Microsoft.

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"The principal reason Microsoft won in the PC competition is the distribution agreement it signed with IBM," wrote Blount in a recent report. "Apple appears determined to not repeat the same mistake with the iPod."

In addition, Cihra thinks that all the attention lavished on the iPod is overshadowing the fact that the Mac business has regained momentum, component concerns notwithstanding. Computer sales in the third quarter were up 15 percent from a year ago and 9 percent sequentially.

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By Paul R. La Monica

"The iPod has been the primary reason the stock has done as well as it has. But if you look at last quarter, Apple started to show some decent growth in the Mac business as well," Cihra said. "Demand is driven more by Apple's own product cycles than PC market trends."

If Apple's stock has been outperforming the overall market thanks mainly to one product's success, just imagine how much more room there could be if all of Apple's units start clicking at the same time.

Analysts quoted in this story do not own shares of Apple and their firms have no investment banking relationships with the company.

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