It might be wise to wait to Buy Apple if you want to Play the 5G Cycle

Raymond James analyst Chris Caso says you might want to jump in early on Apple Inc. NASDAQ: AAPL to benefit from upcoming 5G cycle. He says, “Our call may well be early — we expect this year’s iPhone cycle to be the weakest in years. And today may not be the right time to buy ahead of that weakness. But since the near-term market moves are being driven by macro conditions as much as fundamentals, we’ve decided to upgrade now and let our clients decide the best time to execute on our idea.” 

Along with the recommendation to buy AAPL when it feels right, Caso put a price target of $250 on the smartphone giant. As of this writing, Apple trades at $207.22. That means investors could make nearly 21% on the blue-chip tech company should it reach Raymond James’s projected price-tag.

Since the analyst mentioned fundamentals, let’s take a look at S&P 500 members’ financials to see what it would take for Apple to find $250. During the last five-years, Apple has averaged a growth of a little north of 12%. During the same time, its average price-to-earnings (P/E) ratio was 15.57. That means the company typically traded at a 26.38% premium to earnings-per-share growth.

For 2020, Wall Street’s consensus earnings forecast is $12.53 per share, 11.42% higher than 2019’s outlook of $11.91. Since investors have been willing to pay up 26.38%, it gives us a P/E of 14.43. Break out the calculator and multiply 2020’s forecast with our valuation and Apple’s shares would be significantly lower than where they are today, falling to $180.84. A loss of 12.73%.

Nobody wants that.

To find $250 using next year’s consensus, investors would need to value the company at 19.95 times earnings of $12.53 per share. Considering Apple’s maximum P/E during the last half-decade was 20.64, that would be a near all-out premium for a company with slowing growth. It’s probably not going to happen.

There are couple of red flags in Apple’s most recent financial statements as well. Gross margins fell to 38% for the first six-months of 2019 from 38.37% in the same period of 2018. While 0.37% may not sound like a lot, it’s an amazing $758 million dollar difference on $142.3 billion in revenue. That’s crazy.

We also see that management is ramping up Research and Development to 6% in the first half of 2019 compared to 4.54% last year. Selling, general, and administrative expenses are on the upswing too. The income statement line item also moved to 6% of revenue compared to 5.61% in 2018.

In total, operating expenses increased to 12% from 10.15% year-over-year. That’s an even more amazing $2.647 billion- yes, billion. Ah, a few billion here and a few billion there and maybe we’ll start talking about a lot of money.

Over on the balance sheet, inventory inched up to 3% from January through June this year, compared to 2.65% for the same time frame last year. Standing alone, it’s not too concerning. However, iPhone buyers could put off upgrading their current phones until the 5G cycle starts.

With a new product and technology coming to market, research and development costs are likely to continue rising. At the same time, management will want to dispose of older inventory. Hence, lower average selling prices per unit. Gross margins could continue to shrink; albeit, undoubtedly modestly, but enough to maybe take a few pennies off the bottom line.

Much like margins, APPL share price could be headed for a squeeze with two converging trendlines. The time is near for Wall Street to pick a side between breaking out from descending highs versus ascending lows. The two lines are coming to a point, like the edge of a triangle.

The stock has been weaker than the overall market as Apple’s price did not make a new 52-week high in early July while the indexes did make new highs. There is a bunch of technical traffic ahead between $215 and $225. Sellers would likely take control once again above $215.

At the top of AAPL’s recent range, investors have about $18 in upside, whereas the downside could be as low as $180 or $27ish. In our view, $18 in possible intermediate gains doesn’t make sense in the face of $27 in losses. It’s a losing equation.

Analyst Chris Caso could very well be right in the long-run, and Apple will hit $250, but we think his view that this year’s iPhone cycle being the weakest in years with fundamentals driving the stock price is more likely to play out in the next six-to-twelve months.

Considering our math above, patient, long-term investors could have an opportunity to own AAPL cheaper than where it is today and be closer to the beginning of the 5G cycle.