Apple reported blowout earnings after the stock market closed Tuesday.

Earnings were better than the consensus and the whisper numbers. Still, those numbers are in the rearview mirror. Let’s look ahead: The prospects for iPhone 12, a 5G-based phone, just got better.

However, Apple investors and those who want to buy the stock ought to be aware of a nuanced situation that may develop and increase risks. Let’s explore with the help of two charts.

Two charts

Please click here for an annotated daily chart of Apple

AAPL, +2.83%

stock.

Please click here for a chart of Apple stock compared with the Dow Jones Industrial

DJIA, +0.48%,

S&P 500 ETF

SPY, +0.27%

and Internet ETF

FDN, +0.06%.

For the sake of transparency, this chart was previously published before the earnings report. At that time, The Arora Report had raised Apple’s target to $320, higher than most analysts’ target.

Note the following:

• From the second chart, Apple stock has significantly outperformed the Dow Jones Industrial Average. Apple stock has also outperformed other popular large-cap stocks such as Amazon

AMZN, +0.52%,

Facebook

FB, +1.54%,

Google parent company Alphabet

GOOG, +0.17%

GOOGL, +0.24%

and Microsoft

MSFT, +0.91%.

• The first chart shows four trend lines. Each trend line shows higher price acceleration. Such price acceleration is not sustainable and poses a fairly high risk at this time.

• The chart shows when Apple fell into the Arora buy zone with a low band of $147.31. The Arora Report portfolio has held Apple stock from $18.73. I talked about a $1,000 target for Apple stock (pre-split of 7 to 1); such a high target was unheard of elsewhere at that time.

• Subsequently we have provided several new buy zones that enabled investors to buy Apple stock at favorable prices and also profit from additional trade-around positions. For example, take a look on the left-hand side of the first chart; Apple stock fell from $233 to the Arora buy zone with a low band of $147.31.

• The first chart shows the new Arora buy zone.

• The first chart shows the new Arora very long-term target zone for Apple.

• Volume usually provides important clues, but in the case of Apple, there is not much useful information.

• Since Apple stock is overbought, it is important to look at the relative strength index (RSI). However, as shown on the first chart, RSI on the daily chart provides no useful clues. This is common in a stock that is as strong as Apple and where price has been accelerating.

• Over five years ago when everybody was focused on Apple’s hardware and Apple got a low price-to-earnings (P/E) multiple, I was writing that eventually Apple would get into services in a big way and that would substantially increase the P/E multiple. This is exactly what has happened. Apple’s P/E multiple has gone from about 10 to 24.

• Apple’s service revenues hit a record of $12.72 billion, growth of 17% year-over-year. However, there is a cause for concern. Service revenues came below expectations of $13 billion.

Also read: “Apple’s iPhone didn’t need 5G for a mind-boggling rebound”; and “There’s only one stock millennials prefer over Amazon and Tesla”

Ask Arora: Nigam Arora answers your questions about investing in stocks, ETFs, bonds, gold and silver, oil and currencies. Have a question? Send it to Nigam Arora.

IPhone 12

The biggest jaw-dropping number in Apple’s earnings was 8% growth in iPhone revenues. This was significantly above expectations. It indicates that the iPhone 11 has been a big hit. This portends well for the iPhone 12, which will be a 5G phone. The switch to 5G will start a massive upgrade cycle. It is likely that the upgrade cycle may be even bigger than current expectations. Please see “How and when prudent investors ought to buy these 5G stocks.”

Risks

There are two big risks in Apple stock.

• Apple is very overbought. Usually when stocks are so overbought, they find an excuse to sell off. The first chart shows the new Arora buy zone. There is a 70% probability that Apple will pull back into the new buy zone.

• Valuation of Apple stock is elevated. Paradoxically, as the 5G upgrade cycle unfolds, hardware revenues will go up and that may lead to a lower P/E.

Fair value

In our analysis, a big part of Apple’s run is because of the momo (momentum) crowd and not because of fundamentals. Apple will continue to grow, but in our analysis, in the very long term, the fair P/E range for Apple is 16 to 18. It is well below the current P/E of about 24.

A highly nuanced situation may develop from the success of the 5G iPhone 12. As Apple’s hardware revenue goes up, its P/E may drop.

Disclosure: Subscribers to The Arora Report may have positions in the securities mentioned in this article or may take positions at any time. Nigam Arora is an investor, engineer and nuclear physicist by background who has founded two Inc. 500 fastest-growing companies. He is the founder of The Arora Report, which publishes four newsletters. Nigam can be reached at Nigam@TheAroraReport.com.

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2020-01-29